Attention Generation X: It’s time to address the potential problem with your 401k

March 21, 2013 12:00 am

Derek M. Amey

Partner & Co-CIO

As someone born in 1975, smack in the middle of Generation X, I meet more and more folks my age suddenly trying to tackle financial planning topics. I get asked about strategies to pay down debt, choosing life insurance, college funding for their children, setting up a will and even –gasp- retirement projections!

If you’re like most of Gen-X, your parents originally pushed you into contributing to a 401k. They probably ranted on and on about how the Social Security system won’t be there for us when we retire, and how only you can be responsible for your retirement. The problem for most of you is that is the precise moment when the advice stopped.

Week after week you have been contributing to your 401k, diligently plugging away for the past 10-20 years. Since you have been committed to it consistently, you could have a sizeable nest egg by now. This is great, but saving is just part of the equation. As investors get older, the dollars get larger, the swings in account value can become more volatile and thus the need for a correct asset allocation grows.

Asset Allocation is the process of dividing your investments amongst different types of asset classes, to optimize the risk and reward based on your ultimate goal for your savings. The common error we see for most 30-40 year olds is that they picked an asset allocation when they first opened the account, and then thought they were done. If this sounds familiar, let’s go over some of the most common answers to the question:  “How did you choose which funds to buy in your 401k?”

 

I copied what my mother/father did in their 401k
Sounds like an okay idea, until you consider your time horizon and your risk tolerance. Our parents are fast approaching retirement age, and that means they will start dipping into their savings shortly. For most of them, this causes them to become risk averse and prefer a 401k allocation heavily weighted towards bonds. Bond funds play a key role in asset allocation, but for most of us, retirement is 30+ years away. If your 401k asset allocation looks quite similar to your parents, most likely one of you is investing incorrectly.

I asked a co-worker what I should do
This one is quite common for the college graduate. Faced with a stack of papers from their HR department that most of them have never seen, the 401k allocation worksheet can be a maze difficult to navigate. In a rush, they ask the person sitting next to them what they are doing, and figure “I’ll figure this stuff all out later.” The problem is that the person they asked could have an entirely different view of risk. Risk tolerance is defined as a measure of an investor’s willingness to handle declines in their investment portfolio. How investors feel about risk is quite personal and individualized. Investors should use their perception of risk to help construct a 401k allocation that helps them achieve their goal of retiring while allowing them to sleep at night. The co-worker you asked may drive home at 100mph, something you would never do. How do you know he or she didn’t give you a 401k allocation that is the equivalent of speeding down the highway?

I put everything in the Money Market. I don’t want to lose any money!
We Gen X’ers have had a difficult time with investing. Most of us were just starting out when the dot-com bubble burst. After a few years of modest growth and stability the debt crisis hit and markets crashed. For some investors it was enough to turn them off from investing entirely, I beg of you…do not be one of these people.

Putting your 401k contributions into the money market or stable value fund is not investing, it’s just saving! There may be times where this makes sound financial sense. However, if this 401k is going to be used for your retirement and that retirement is still 20-30 years away, money markets returns may be eaten alive by inflation. The basics of investing, in my opinion, revolve around creating a diversified portfolio, investing consistently and reviewing and rebalancing your portfolio on a regular basis. If you open your 401k statement and the only fund you own is the money market, it’s time to strongly consider making a change.

I put a little money into each, isn’t that what diversification is?
Diversification is a strategy whereby the individual positions in a portfolio have different risk parameters and by combing different asset classes with different economic risk characteristics, the overall risk of the portfolio is reduced. Far too often we meet folks who think by owning 9 different funds they have achieved a diversified portfolio. The problem is that those 9 funds could most likely be equity funds. Owning 3 different small cap equity mutual funds and 5 large cap equity funds means you are still at the mercy of stock returns.

Alternatively, owning some bond funds would reduce the risk of the overall portfolio, because in general, bond funds tend to outperform equities when the economy struggles. Commodity funds could do well in periods of high inflation and diversify a portfolio because their performance can be far different from equities funds or bond funds. In a year like 2008 when markets were crushed, the lack of diversification in investors’ portfolios really hampered their returns. If you don’t fully understand diversification, it might be time to seek professional help so that when the next period of market turbulence hits, your investments can ride out the volatility.

I have zero idea
This is another honest answer that is seen far too often. Someone once said  “Hope is not a viable investment strategy”, and for the folks who fall into this camp, hope is about all they have to hang on to. When you were in your 20’s, and your 401k balance was in the “four figures”, this wasn’t an ideal investment strategy, but learning to budget and save consistently was far more important than asset allocation. It’s now time to wake up and realize we’re not in our twenties anymore and how your investments perform is an important part of being able to achieve your retirement goals.

OK, Now What?

Look in the mirror and figure out if you really want to do this by yourself
This is the first and most important step. There are plenty of online tools to help the do-it-yourself investor, and with hard work, dedication and consistent attention you may achieve your financial goals. However, you need to do some soul searching to figure out if you really are dedicated to doing this consistently over the next 20-30 years. The financial world can be a challenging maze to navigate, and if you aren’t committed maybe it’s time to meet with a professional.

If you still prefer to “go it alone”:

•    Get a sense of what your basic financial needs in retirement will be
Google “Retirement Calculators” and you will find a plethora of offerings. Try a few out just to get a basic idea of where your goals might be.
•    Take a risk assessment questionnaire to get a sense of your risk tolerance
Google “Risk Assessment Questionnaire” or “Risk Tolerance Questionnaire” and fill out a few to get a sense of how you perceive risk.  StrategicPoint has one here.
•    Get educated
Visit your 401k provider’s website and review your plan. If you work for a large organization, contact your HR department and see if they have any resources to help you plan and strategize.

Derek Amey serves as Financial Advisor and Portfolio Manager at StrategicPoint Investment Advisors in Providence and East Greenwich. You can e-mail him at damey@strategicpoint.com.

The information contained in this post is not intended as investment, tax or legal advice. StrategicPoint Investment Advisors assumes no responsibility for any action or inaction resulting from the contents herein. Derek’s opinions and comments expressed on this site are his own and may not accurately reflect those of the firm. Third party content does not reflect the view of the firm and is not reviewed for completeness or accuracy. It is provided for ease of reference.