Saving for retirement is tough enough. Besides the need to actually defer the money from each check into your 401k plan, you basically are left to your own devices to choose the best investments for your situation.
It is important to avoid investment decisions that can hinder your chances of accumulating a sufficient retirement nest egg. Misusing the following assets might poison your 401k plan.
By cash I mean a money market fund or a stable value fund. Many money market funds currently pay interest rates as low as 0.01 percent. Stable value funds are doing a bit better, with many around 1 percent.
Relying too heavily on either of these investment vehicles is likely to bring you up short of your retirement goal. Cash is fine as a hedge against volatility for a portion of your portfolio, but I’ve seen younger plan participants in their 20s who have the majority of their account in the plan’s cash option. In fact, I once advised a plan where the majority of the firm’s hourly workers under 30 had their money primarily in cash.
The reasons for overusing a plan’s cash option might include:
- Fear of investment losses
- Difficulty trying to decide which investment options to choose
- Simple neglect
No matter the reason, the end result of overusing the cash option in your 401k plan is that you will come up short at retirement.
2. Company Stock
If you are ever tempted to over indulge in your company’s stock within your 401k plan, just find a former Enron employee and listen to his story. No matter what the company is or how good an investment the stock might seem to be, overdoing it here is a huge risk.
According to John Vyge, a certified financial planner and founder of Hillebrand Financial Planning in Reston, Va., “If the company they work for loses value, their portfolio can go down substantially.”
As an employee, you depend upon your employer for your livelihood. If that employer hits a rough patch, you might find yourself unemployed and without a source of income. If you have loaded up on company stock in your 401k plan and that rough patch impacts the stock price, you might find yourself both unemployed and with a greatly diminished 401k plan balance.
Vyge said company stock in your 401k plan should not exceed 5 to 10 percent of the plan’s overall balance.
3. Emerging Market Funds
In my experience, emerging market stock funds are not generally a core asset class offered in 401k plans. Instead, plan sponsors offer these funds as a way to round out a plan’s investment menu and to add a diversification vehicle for plan participants.
There is nothing wrong with investing in an emerging markets fund. However, this is a place where investing too heavily can have a negative impact on returns.
The Vanguard Emerging Markets Stock Index Fund (VEIEX) has gained an average of 7.3 percent annually over the 15 years ending Sept. 30, 2015. This compares to an average gain of 3.84 percent annually over the same time frame for the Vanguard 500 Index Fund (VFINX), which invests in 500 of the largest U.S. companies.
However, that advantage came with a bumpy ride for investors, and much of the advantage occurred during the first decade of this century. Over the 10 years ending Sept. 30, the Vanguard 500 Index Fund gained an average of 6.68 percent annually versus 3.99 percent for the Vanguard Emerging Markets Stock Index Fund.
And for the preceding five years, the Vanguard 500 Index Fund gained an average of 13.17 percent annually versus a loss of 3.5 percent per year for the Vanguard Emerging Markets Stock Index Fund.
While long-term holders of the emerging markets fund did better over the 15-year time frame, those gains still came with about 55 percent more volatility than an investment in the other Vanguard fund. Investors over shorter time horizons did not fare as well and might have suffered a loss. Investing too much in a risky asset class based on solid prior returns could derail your 401k returns.
4. Brokerage Windows
Brokerage windows are not an asset per se but rather an option offered by a number of 401k plans that allow participants to self-direct all or a portion of their 401k accounts into assets outside of the main plan menu. Some brokerage windows allow participants to invest in mutual funds. Others offer access to a wider array of alternatives, including individual stocks and ETFs, in addition to mutual funds.
Plan sponsors often make employees who choose this route sign off that the employee understands the risks of directing his own investments. This helps reduce any liability on the part of the plan sponsor. This option can certainly be great for some participants, especially those who are particularly investment-savvy or who work with a financial advisor. In the latter case, this option can allow the participant’s 401k account to be invested in synch with his outside investment assets.
However, a brokerage window becomes a toxic 401k option when employees invest in a manner that is not in their best interests. Perhaps they want to use the account to do frequent trading or to invest in risky, exotic sectors of the market.
One Forbes article cited questions from the Department of Labor (DOL) about brokerage windows. Among other things, the DOL wants to know if there is evidence of good or poor decision-making and outcomes by participants using brokerage windows. The DOL also wants to know how plan fiduciaries monitor investments made through the plan’s brokerage window, if at all.
Plan participants looking to invest some or all of their account balances in a brokerage window should fully understand the risks and be realistic about their own investing abilities.
Related: How Much Will My 401k Be Worth?
5. Proprietary Mutual Funds
Depending on your company’s 401k plan provider, your plan might be chock full of proprietary mutual funds from a single fund company. This isn’t to say that all such funds are bad. Mutual fund families such as Vanguard and T. Rowe Price administer 401k plans and offer many excellent low-cost mutual funds as well.
On the other hand, many plans via brokerage houses and banks offer their own high-cost proprietary mutual funds. As an example, earlier this year Ameriprise agreed to a $27.5 million settlement in a class action lawsuit over the cost of some of the mutual funds offered to employees in the company’s 401k plan.
Writing about another company — Wells Fargo — in U.S. News & World Report, Daniel Solin said the company’s representatives caught his eye when they advised a prospective 401k client of their ability to select winning fund managers. Solin wrote, “I ran an analysis of the ‘Wells Fargo Advantage Funds’ (its proprietary funds) for the ten-year period from January 1, 2002 to January 31, 2012. I found that 64 percent of these funds underperformed their Morningstar-assigned benchmark during this period.”
If your plan is filled with proprietary mutual funds or even with funds that are all or largely from a single family, you need to be diligent and choose the best options available. The danger is that even if you choose the right asset classes and allocate your money appropriately for your age and risk tolerance, your performance might suffer due to the potential poor performance of the funds available to you.
If there is a match available in a plan you will want to invest enough to receive the full match. Beyond that, do your homework and consider voicing concerns to your employer, possibly in concert with co-workers who feel the same way.
In the end, you do not have any control over which investment options are offered by your employer’s 401k plan. But you do have control over where and how you invest your retirement savings. Become knowledgeable about your plan’s investment choices. Find out which options best suit your goals, time horizon and risk tolerance.