When a Simpler 401(k) Is Just Dumb
by Jeff D. Opdyke
Tuesday, August 7, 2007
Employers have long hoped that simpler 401(k) plans would entice more workers to save. But for more-savvy investors, that may not be good news.
Many companies have pruned the number of investment options in their plans to keep workers from feeling overwhelmed by too much choice. General Motors Corp. and Delphi Corp., for instance, recently cut these options by nearly half. Meanwhile, other companies have loaded up their plans with a slew of target-date funds — one-stop shopping for retirement savers — while shrinking the variety of other funds.
But simple isn’t always better. In paring choices, companies may be reducing workers’ ability to diversify their assets, leaving them exposed to the downdrafts that sometimes roil stocks and bonds simultaneously.
As 401(k) plans become the primary retirement vehicle for more Americans, the problem is they don’t work like traditional pension plans, which often diversify beyond stocks, bonds and cash. But with a little creativity, you can better mimic the kind of portfolios that pension plans rely on to ensure the long-term survival of their assets.
• Deconstructing pension plans. To diversify risk, some 401(k) plans have added options such as real-estate investment trusts and Treasury inflation-protected securities. But pension plans also rely on such alternative investments as commodities, high-yield bonds and currencies. Such assets can be minimally correlated with stocks, and can provide a greater degree of risk reduction while enhancing returns.
Wall Street in recent years has launched a host of new funds that make owning such assets easier and safer. IShares, iPath and PowerShares sponsor exchange-traded funds that invest in commodities ranging from oil to precious metals to agricultural products and cattle. Funds from Cohen & Steers and Alpine Funds offer investors exposure to real estate, at home and abroad. Several bond funds, such as Vanguard Inflation-Protected Securities, give investors exposure to Treasury bonds that shield against inflation. Meanwhile, IQ Investment Advisors, Deutsche Bank and Rydex Investments recently introduced funds that offer foreign currency exposure.
• The IRA gambit. How do you own such assets in a retirement account when your 401(k) doesn’t make them available? For sophisticated investors — those who prefer to manage their own assets — the answer is to use IRA contributions to hold the assets you can’t access in the 401(k).
David Kudla, chief investment strategist at Mainstay Capital Management, a Grand Blanc, Mich., investment firm that works with many auto-industry workers, says he’s seen “newfound interest” from 401(k) participants in opening IRAs to gain broader access to different assets. He says some companies even allow a so-called in-service rollover, in which you roll a portion of your 401(k) account into an IRA while still employed.
Before putting money in a Roth or traditional IRA, however, make sure you’ve contributed to a 401(k) plan up to the point you receive all of the company match. Earn too much to contribute to an IRA? About 20% of all 401(k) plans now offer a brokerage window, which allows participants to purchase a wide range of products within the retirement plan.
As a rule of thumb, no alternative assets individually should exceed 5% to 10% of your portfolio. Cumulatively, investors should have no more than about 40% of their portfolio in alternative assets, though more conservative types will want to scale that back to 15% or 20%.
For investors with no interest in hands-on management, the answer may lie in lifecycle and target-date funds, those increasingly popular products composed of different asset classes in which the investment mix automatically changes over time. Some newer versions of these all-in-one funds have stepped out of the plain-vanilla mold.
AllianceBernstein, an investment-management firm, is currently rolling out a new 401(k) plan for its employees. Although it reduces investment options for active investors, the new plan improves the target-date funds by including 11 asset classes in the mix, including global real estate, high-yield bonds and inflation-protected securities.
“It’s the best way to give workers exposure to more-exotic asset classes: a product managed by pros,” says Dick Davies, a senior managing director at the firm.
