Sunday, July 15, 2012

The 401(K) Mess

It still amazes me that the prime method of saving for retirement is a closed system that allows limited investment options chosen by the employer where highs costs aren't disclosed. Clearly the 401(k) system is better than nothing at all and the old pension system. It just needs to be modernized to catch up with the current fast paced world.

When I left Verzion a couple of years back, the whole process of moving my 401(k) out of the control of Verizon and into a IRA at Fedelity was enlightnening. As somebody interested in the stock market and becoming a financial advisor it was always very frustrating to see my wealth accumulating in a 401(k) plan with little ability to direct my investments other than basic mutual funds.

Verizon of course had a strong plan compared to most in the industry with a high matching contribution and a decent selection of funds. Unfortunately though it didn't always provide the options that I wanted and expenses weren't readily available.

As the financial markets have become more open and readily accessible to all investors, it just doesn't make any sense that money isn't transferred into an IRA for the employee at say a Fidelity or a Vanguard with full investment options. Any argument against it doesn't add up.

In my case, the government and Verizon (or MCI before) weren't confident that I could manage the first $10, 20, or 30K in my plan, but after 10+ years of accumulating wealth, both had no problems with just handing over the money and letting me go my own way. So at my max valuation the money was placed in a Fidelity account with free reign. Talk about a recipe for disaster.

Sheltering you kid for 18+ years and then just kicking them out of your house doesn't make sense either. Would you let your kid move out without basic skills such as cooking, cleaning, and laundry? Why does the investment world do that?

Employees are sheltered with the corporate 401(k) for decades and then let loose without any care or clue whether the person can handle the cash hoard. Wouldn't it be better to go directly to the IRA plan? And instead of having a telecommunications company responsible for an employees financial future have it immediately turned over to a financial firm. One that can set up webinars for new employees that must be watched before allowing trading in an account. Until then any money could accumulate in a money market fund.

In this plan, employees start learning the real financial world and all the options and pitfalls when their accounts are small and not when they get laid off at 55 with a $700K payout.

Tom Petruno of the LA Times published an article talking about strategies for navigating the 401(k) jungle. It is worth a read for anybody wondering what to do with their 401(k) money. Below are some highlights from his article:


  • The average plan offered 19 separate investment choices in 2011, according to a Vanguard Group survey. That was up from 16 in 2002. (limited options)
  • Target-date funds have exploded in popularity with 401(k) plans over the last few years. Eighty-two percent of plans now offer the funds, up from 58% in 2007, according to Vanguard. And 47% of plan investors use a target-date fund, up from just 18% in 2007. (good concept but what about performance)
  • In the last few years more companies have adopted two features aimed at boosting employees' 401(k) savings rates. One is automatic enrollment, meaning a certain percentage of your pay automatically goes to the 401(k) unless you opt out; the second is automatic escalation, meaning your contribution increases each year until it reaches a set limit. (great idea especially in matching plans)
  • Despite the prevalence of company-sponsored advisory programs, relatively few workers have taken advantage of them. Across plans of all sizes, just 22% of participants sought advice in 2010, the Plan Sponsor Council said.

Naturally nobody will listen to my plan so employees need to take it upon themselves to learn the best way to take advantage of their 401(k)s. Typically a diversified portfolio will do in the early years with the more important determinant of account growth being the contribution amount. That is the time for investors to gather knowledge on investments or begin working with a financial planner. Then when the account becomes large enough that investment gains begin outpacing contributions, the person is ready to mange the money. 

Please feel free to contact us at info@stonefoxcapital if you have any questions. 


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