Wednesday, February 28, 2007

6 Reasons to Roll-Over Your 401(k)

After leaving their job for a new one, many people leave their old 401(k) with their former employer. They do so for a variety of reasons: they forget to move it; they are too lazy; they think their old 401(k) is a good deal etc. However, I am of the opinion that once you leave your employer, your retirement savings should leave as well.

Here are 5 reasons why you should make the effort:

1. Your 401(k) May Be a Bad Deal - it is truly amazing how many bad 401(k) plans are out there. I intend to cover the topic in a future article using what I learned as a member of my company's 401(k) plan management team. Some plans impose attrocious expense rates, wrap charges and other needless costs. Why bear these costs if you don't have to?

2. Expand Your Investment Options - most 401(k), even the good ones, restrict their participants to a few investment options. In many companies those investment options are selected by the HR team... a team qualified for this task mainly by... nothing. Worse yet, in some companies the investment options are chosen by a broker, who may or may not be giving your company impartial advice. Roll your money out and make your own plans.

3. Consolidate Your Accounts - how annoying is it to get 17 different statements from several different financial institutions? By consolidating your old 401(k) plans into a single IRA you can manage your portfolio in a single account and get complete picture of your investments all in one place. Even more importantly, by rolling out several accounts into one you can sometimes save on expenses. For example, The Vanguard Group offers substantially lower expense ratios for accounts that pass a certain size threshold (these are even lower than their already low fees).

4. Avoid the Money Market Trap - in some cases, if your former employer is unable to make contact with you and your previous investment choices in your 401(k) are no longer available, your investments may be placed in some sort of stable principal fund, i.e. the place where money goes to die. If you forget to follow up, it may be years before you realize that your hard earned retirement investment is earning 2% a year. Seriously, just take your money and run.

5. Tracking Your Money - the funds in my company's current 401(k) plan, like those in many similar plans, do not use ticker symbols and are not easily trackable. In many cases this is true for companies whose 401(k) plans are managed by an insurance company (ING, Hartford etc.) By rolling-over your 401(k) into an IRA you will be able to invest your money in funds for which a public price is posted on a daily basis. You know, like one of those things that people actually want to invest in...

6. Index Investing - it is amazing that after all this time, most 401(k) plans offer only minimal index fund investment options. My own company's 401(k) plan offers none. I am stuck with a choice of only actively managed funds. Even those plans that offer some indexing options don't offer enough of them. For example, when speaking with Fidelity on behalf of my company last week, I was told that their 401(k) platform does not include any international indexing options. As many of you know, a majority of actively managed funds underperform their stock market benchmarks. Yes, that's what we like: paying more for less performance... Why would you want to be stuck with that?

Convinced yet? Well if you're not, stay tuned. I will be writing a lot more about the problems with 401(k) plans and how an ordinary employee can drive a change in his company's retirement plan.

Tuesday, February 27, 2007

Investing is not Entertainment.

Stocks closed dramatically lower on Wall Street today. The pundits are preaching. The analysts are analyzing. The CNBC investotainment machine is on a roll. The DOW closed down 416 points. The NASDAQ is down 96. Fear in the streets.

What does all that mean to you? If you are smart and have a long term investment horizon it means absolutely nothing. Why should you care? The stock market goes up, the stock market goes down. Just as you should not uncork the champagne on good days, you should not go into mourning on bad ones. All that matters is the long term expected return. If your portfolio is well diversified, your long term investment outlook should not change based on today's market results (or indeed, based on this year's investment results).

Build a diversified portfolio, hold it, and ignore the hype. Expect up years, expect down years. In the long run your investments will probably do OK. The best way to drive down your returns is to invest based upon market fluctuations.

Sit tight, friends. Ignore the hype. Investing is not about entertainment value, it is about long term expected returns.
It's Great to be Average!

For my first post on this new blog, I want to relate a conversation I had with a friend earlier today. My friend recently invested in shares of EMC (NYSE: EMC), and did so based on information that the company is about to spin off their VMWare division. Although EMC may be a good investment (I don't know), I am questioning the wisdom of buying and selling individual stocks.

The typical investor gets most of his information from the mainstream news media. This information is widely known, and in all likelihood the same information is known to professional traders, brokers, investment bankers and research analysts (unless you are using illegal insider information). If the "big boys" have access to the same information they have probably acted on it and the price you will pay for the stock already reflects the good or bad information you are using to make your trading decision. In other words, the information you plan to use is probably already priced into the stock.

What strikes me as amusing is that in every stock transaction there is a seller and a buyer. The seller sells the stock because he thinks the price of the stock is about to drop. Of course, the buyer buys because he believes the opposite. If you trade a stock you are essentially betting that you understand the market better than the guy on the other side of the deal. However, the guy on the other side of the deal is probably a professional or institutional investor who gets paid to know the market and who specializes in a narrow group of target companies.

While most people never dare to claim that they can beat a professional tennis player in a 1:1 tennis match, and most sane individuals will not try to beat a professional race car driver at his own game, many think they can beat the professional investors at stock picking. Can anyone tell me why that is?

Now the punch line: research shows that most people can achieve better returns on their investments than can a professional investor. The strategy for success is simple: invest in an index fund and don't trade. This strategy essentially guarantees you a return equal to the average market return. Most professional investors under perform the market.

In summary: if you are both picking stocks, the professional investor has an advantage. He has more information and investing is his day job. Even armed with all this research and information, the typical professional investor will under perform the market. You as a private individual have an even smaller chance of beating the market by picking stocks, but by indexing you can assure yourself of average market returns.

Here's to being average.