Many companies that have stopped matching employees' 401(k) contributions when the economy tanked, are now thinking about renewing these matching contributions. My wife's company is one such employer, and there is talk that the company will begin matching contributions again in the coming months. In such a situation, should you stop your contributions until the company renews its matching or should you stick to your guns?

The benefit of delaying contributions is obvious: wait a few months and the same money that you would contribute now with no employer matching will yield a guaranteed return in the form of employer moola... However, there are a few arguments I can think of against this strategy. For one, unless you know for sure that your company will be renewing the match, you are delaying contributions that could be invested in the market and yielding a return (assuming the market goes up, that is). For another, if you delay your contributions, will you have the discipline to max out your retirement savings for the year when the matching actually begins, or will you leave money on the table? There is also the question of how matching is to be calculated. Many companies limit matching to a percentage of employee pay in a given pay period, meaning that stacking all your contributions may not give you the desired bump in employer matching funds.

My wife and I discussed the option of delaying her contributions, but have not yet made a decision. Any opinions or suggestions?

My company has never matched employee contributions, nor is it likely to do so in the foreseeable future. Let's just say that for now I am happy to have a steady paycheck... :-)

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Alpaca's 401K - More Developments

Two days ago I wrote a post about Alpaca's new 401K plan and about how we chose the ROTH 401K option for her. A comment by one of my anonymous readers changed my mind. He directed me to this post by the Finance Buff, which is extremely informative and well written. I thought that most of the arguments offered against ROTH 401K, while valid, did not apply to Alpaca and I. However, one specific argument hit right home: AMT...

The darn stealth tax. I didn't think about that when we looked at the ROTH 401K option. In 2008 we were caught by its nasty snare. In 2009 I think we will narrowly escape its grasp since Alpaca was unemployed for much of the year and worked as a part time contractor for much of the rest. However, if both Alpaca and I remain employed this year (keep those fingers crossed, people), AMT is pretty much assured. We have 3 kids, make a decent living and live in California - a high tax state. These are all crimes and misdemeanors that justify a fat fine under the American tax code. Damn it. I knew I should have opened an investment bank or mortgage company. That way we could have been getting all that taxpayer money instead of being actual... taxpayers...

Anyway, no more ROTH 401K. This morning Alpaca switched her contributions to a traditional 401K. This anonymous reader probably saved us a nice chunk of change. Thank you, anonymous. Watch the skies for that Bat Signal, in case we need you again! I guess writing this blog has some value after all... :-)

In other (good) news, Alpaca received notice today that her 401K plan was changing its fund line-up, and will from now on include an international index fund (FSIIX) with an impressively low expense ratio of 0.2%. Consequently, Alpaca will dump her previous international fund choice (allocated at 10%), reduce her Total Market Index contribution from 70% to 50% of her allocation, and will allocate 30% of her contributions to the new international index fund. This will bring Alpaca's 401K contributions more or less inline with our overall portfolio asset allocation.

Next week my own Fidelity 401K representative will be visiting our office, and I intend to make a vocal case for the inclusion of the same international index fund in our own plan.

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Questions for Your 401K Plan Administrators

Not all 401K plans are created equal - some can be pretty good while others lack important features or impose ridiculous costs on participants. In my previous company I was involved in running my employer's 401K plan (read this post for that interesting story). In my current company I haven't done anything about our plan, primarily because I thought it was reasonable from the get-go, but also because I found my work as a new executive to be extremely interesting and challenging - quite frankly, I just didn't have the time. It has been almost two years since I started my current position (it's amazing how quickly time passes), and I am now thinking about pushing for some changes in our 401K plan. This week a plan representative will be coming to visit us for a "lunch and learn" session and I was planning on bringing up a few issues that I think we need to address. Here they are:

Roth 401K - my company offers only a traditional 401K plan. No Roth 401K. Given prevailing expectations that tax rates will only go up in the coming decades, being able to squirrel away retirement savings without having any future tax liability is a pretty attractive proposition. Alpaca and I "make too much money" to invest in a ROTH-IRA, but participation in a ROTH-401K has no income caps. The mission: get my company to adopt a ROTH-401K option.

Expenses - as far as I can tell, Fidelity has been pretty above board with their disclosure of plan expenses. Checking my 401K account the other day, I was able to find a line that stated very clearly a charge of $30 for plan expenses in 2009. Obviously, this charge is on top of any expenses charged by the mutual funds themselves. Nevertheless, 401K plans are renowned for having all kinds of hidden fees and charges. In my former company even the 401K committee (of which I was a member) did not have clear information about what our employees were paying in fees. We were simply unable to get that data from our plan provider. Fees are a major scourge of the long term investor. They can quietly leech away returns without a lot of evidence that this is happening. The mission: get full disclosure of plan fees.

Index Funds - most of my 401K money (70% of my allocation) is directed towards Fidelity's excellent total market index fund, with an expense ratio of only 0.1%. However, this is the only index fund available in the plan. International index? Nope. Bond index? Niet. REIT index? Better luck next time. Once again, it goes back to the issue of expenses. I don't believe that fund managers can beat their benchmark indexes in the long run, and if that is the case, why should I pay them for the disservice they are doing to me? The mission: Let's have more index funds and fewer fees.

Automatic Re-balancing - Fidelity offers automatic re-balancing of plan funds, but it only allows this on an annual basis. I re-balance my funds quarterly (I think it's particularly important after such dramatic asset price increases as we've had in recent months), but I need to do this manually. The mission: can we have quarterly automatic re-balancing options?

Opt-Out Enrollment - I am a big believer in the concept that employers need to nudge employees to make the best long term decisions. Automatically enrolling people in the 401K plan unless they opt out is a great way to send a signal to people that they should be thinking about saving for their retirement.

My company's 401K plan is run by Fidelity and overall, I am very happy with the plan. Documentation is plentiful and simple to understand, the website is easily accessible and manageable, and fund choices (for the most part) are reasonable. Still, there is always room for improvement.

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How Investing into the Crash Worked for Us

Throughout the stock market melt down we kept our stock positions and even invested more money in stocks. We did this across our portfolio, but the ultimate results of this strategy are most visible in my 401(k). I max out my 401(k), every year. This is not discretionary, it's something that I must do to ensure that my wife and I are economically secure when it's time to retire.

The nice thing about 401(k) contributions is that they happen every two weeks like clock-work, meaning that you invest regardless of whether the market moves up or down. Market timing is not a factor. As the market fell, my existing portfolio fell hard, but my new contributions were purchased at a huge discount. When the eventual rebound came, those discounted purchases more than off-set the original losses.

I only started contributing to my 401(k) plan in May 2008, and suffered through the worst of the bear market, but as of last Friday, my 401(k) was solidly in the black, as you can see in the chart below.

Of course, this is only the case because my regular contributions were large relative to the funds already invested, but still, I think this gets the point across: buying buying low pays off when the market turns around. If I shifted to a more conservative stance following the declines, my 401(k) portfolio would not have been above water today.

BTW, the pic may be a bit too small to make out the details, so here here's a quick guide: the blue position is an S&P 500 index fund; orange is an international stock fund; yellow is a REIT fund; and green is a bond fund. My allocation is 70% for S&P and 10% for each of the other funds. I re-balance quarterly. The regular jagged line shows the bi-weekly contributions and their cumulative value.

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Even for 401(k) - Vigilance Pays

This week we got proof again - as if we needed it - that you should always be vigilant where your finances are involved. I manage our finances using Quicken. It's my way of keeping an eye on all our accounts in one place and making sure that mistakes or even dishonesty don't whittle away at our resources.

Two examples from the past week:

Our dry cleaner charged us $40 to clean a single shirt. $4 was the agreed upon price, and somehow a zero got added to the mix.

A bigger mistake appeared in my 401(k) account. I noticed last week that my mid-month 401(k) contribution never showed up in my account. I waited a few days to make sure that no simple technical glitch was involved, and over the weekend I sent an e-mail to our HR person. Turns out that the company simply did not fund employees' 401(k) accounts since the HR person was on vacation. Hmmmm. Err, OK. That makes sense. Actually, it doesn't. They made the deduction from my salary but sat on the cash? That doesn't strike me as particularly fair.

Still, since this doesn't typically happen, I'll let it slide, I guess.

Our VP of Finance asked me how I found out that the account was never funded. He was pretty surprised to hear that I keep an eye on all my accounts through the magic of Quicken. I got my eye on you, dude. Stay away from my cash.

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Reader Question: Selecting 401K Investments

Recently I received the following question from one of my long time readers:

"I have a question about how to select among the funds offered in a 401k/403b plan. My employer offers several funds for each fund category (international, large cap, mid cap, etc...). Every so often new funds are being introduced and I'm not sure whether the new fund would be a better one in that category than the one I have. So how does one choose? By always picking the lowest cost fund? By comparing the fund performances over the past 5 or 10 years? By comparing against an index? (and then which one?)

Florin"

First of all, I want to thank Florin for sending me the question. I love getting e-mail - questions, comments or ideas - from my readers. That's a large part of why I blog. I respond to each one of my readers (not so much to commercial solicitations), and if you send me a question and include your website, chances are I will respond to your question on this blog and include a link to your site. Anyway, I already responded to Florin via e-mail, but here is a more detailed answer to his question:

What Florin is facing is the reason that when we redesigned our 401K plan at my previous company our advisers advised us to select a relatively small number of funds, that covered the necessary asset classes. By his questions Florin is clearly a financially literate person, yet such decisions are not easy ones to make and many feel confused or overwhelmed by them. 

When selecting funds for my own 401K, I follow a pretty straight forward process that may work for others as well:

Decide on an asset allocation - simply described, an asset allocation is the mix of assets (stocks, bonds etc.) that you own. The way you allocate your assets should be based on two main factors: your investment horizon and your willingness to accept risk. Here is a more detailed post on asset allocation for additional background. 

When building my asset allocation plan I do so for my entire portfolio, not just for my 401K - taking into consideration all the different accounts and my wife and I own. It doesn't make sense to optimize my 401K allocation unless the strategy fits our portfolio as a whole. Generally speaking, I try to put my tax inefficient funds in a tax deferred account (e.g. REITs that keep throwing off dividends that would otherwise be taxed, can be sheltered by a 401K).

By the way, our own target asset allocation is approximately 45% US stocks, 30% international stocks, 15% bonds, and 8 - 10% real estate (through REITs). For reference, my wife and I are in our late thirties and are fairly tolerant of risk, i.e. we don't sell our equity positions in a down market...

Find Funds that Fit the Planned Asset Allocation - here's the trick: since we do our asset allocation across the entire portfolio, if I don't find a fund that I am happy with for a certain asset class in our 401K plan, I don't sweat it. I simply buy the appropriate fund in another one of our accounts and balance my 401K allocation appropriately. This is important because many 401K plans offer limited or unacceptable fund choices for one or more asset classes. 

Selecting Between Similar Funds -  If there are several funds in a given asset class, I typically choose between them according to the following priority: 

(i) index funds first - as I explained in my very first post on this blog, I am a big believer in index investing; 

(ii) comparing expense ratios - look, the expenses and fees that you pay for investing in a mutual fund may not always be the most important thing about investing, but I have found few exceptions; 

(iii) comparing morning star ratings - if we are talking index funds that's not relevant, but if an index is not an option, checking up on the fund rating is a good idea; 

Florin also asks a very prudent question: which index should you compare the performance of a fund against to determine the fund's success? 

Investors should understand that they can frequently gain a higher return by accepting a higher degree of risk (you can read about this in my advanced portfolio building series). So the fact that a certain fund generates a higher rate of return than a broad stock index does not necessarily mean that it is an appropriate investment for you or that it is actually out-performing the relevant index. To measure the true performance of a fund, measure it against the return of an index that more or less covers the same asset class. For example, a large cap fund can be measured against the S&P 500 while a fund investing in small caps would be better measured against the Russell 2000 index and a real estate fund may be better compared against Vanguards Total REIT index fund or similar real estate benchmark.

Finally, if you feel confused by the range of options offered by your 401K plan - there is nothing wrong with selecting a target date or lifestyle fund that will do the asset allocation for you.

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Dismal 401K Results. A Great Opportunity!

A colleague came to me earlier this week and commiserated that when he got his 401K statement for 2008, he found out that his 401K lost 9% in the last quarter of the year. He asked how my 401K was doing, and I admitted that I didn't know but that I could check on the spot and tell him. I logged onto the Fidelity website and checked the numbers: down 22% between October and December. My friend was shocked. How could I have lost 22% in the last quarter alone? I explained that since I have about 30 years left to retirement, I am aggressively invested and don't mind taking some risk for a chance at a higher return. My friend, who is much closer to retirement than I, was aghast.

I believe that my 401K asset allocation is appropriate for my age and risk tolerance, and besides, I manage our investment portfolio as a whole, not considering my 401K independently. My asset allocation in the plan is as follows: 70% S&P 500 index fund (this is a good fund with a 0.1% expense ratio - pretty impressive); 10% in a real estate fund; 10% in a bond fund; and 10% in an international fund. Normally my international allocation is closer to 30%, but the international fund offered by my plan is actively managed (I typically invest only in index funds) and charges a hefty expense ratio to boot.

As you would expect, all of my 401K funds have taken major hits over the past year, with the international and real-estate funds showing the biggest declines, as similar investments did in the rest of our portfolio. Nevertheless, I am unfazed. Retirement savings are the very definition of long term savings and with retirement approximately 30 years away, now is the time to take some investment risk in an attempt to grow a sizable asset cushion. It's not that I enjoy looking at these losses, but as I have previously written these declines represent an investment gold mine for those of us who will be net savers over the next couple of decades.

Hey, don't listen to me. Listen to Warren Buffet - supposedly he thinks now is a good time to be in equities.

What does your 401K look like these days?

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Over Contributing to Your 401(k)

A company 401(k) is the basis for many people's retirement planning strategy, and for this reason investing your 401(k) assets wisely is something you should take the time to plan and execute. However, today's post is not about investing your 401(k) money more efficiently, it's about making sure that you don't over contribute to your plan. In 2008, the contribution limit is $15,500 per individual, and if you are over 50 you are entitled to make catch-up contributions of an additional $5,000. Contribute more than this limit and you find yourself in a little bit of a bureaucratic nightmare.

First up, how can one even over contribute? Plan administrators typically ensure that employees cannot over contribute, by stopping all excessive contributions. However, they can only do this if they are aware that you are over contributing. If, for example, you switched jobs mid-year, there is no way for administrators to know the amount that you already contributed to your 401(k) before you joined your new employer. In fact, my wife and I each ran into an over contribution situation in exactly this way.

So, how do you avoid this over contribution situation?

(i) Calculate Your Limit - if you contributed to more than one plan during the year, deduct your earlier contributions from the maximum allowed contribution to determine how much you can still contribute. Once you have this number, divide it by the number of pay-checks remaining in the year and make sure that your contributions do not exceed this number.

(ii) Mind Income Changes - if your contributions are set as a percentage of your income, and you receive a raise before the end of the year, be sure to adjust your contributions to account for this increase to avoid over-contribution.

(iii) Pay Attention to Bonuses - if you are lucky enough to receive an unscheduled bonus, be sure to check if 401(k) contributions have been deducted from your bonus, and adjust your contributions accordingly.

What to do if you over contribute? Contact your payroll representative as soon you discover the error. Your 401(k) plan will issue you a refund check, which will be taxed at your normal income level. In some cases, if you discover the error after the end of the tax year for which contributions were made, you may also receive income that will be attributable to the following tax year. It's a hassle best avoided. Trust me. Last year, after switching jobs in the middle of the year, my wife unintentionally over-contributed to her 401(k). We only discovered the error in February when doing our taxes, the error took until early April to correct, and the changes will also impact our 2008 tax return. As I said, best avoid this hassle if you can.

By the way, if you are interested in improving your company's 401(k) plan, you may also be interested in this previous post.

My New Fidelity 401K Plan - a Review

About two months ago I moved to a new company, but until last week I haven't signed-up to my new 401K (don't worry, I will still maximize my contributions this year). Our plan is managed by Fidelity - which is one of the firms that I was considering when I was evaluating new 401K providers for my last company. Here are some of the dismal facts:

No Company Match - yup. There you have it. My company does not match any employee contributions. This is a bummer, but please understand that my company is a venture backed start-up. We have about 40 employees and no revenue yet. If the money runs out, the company will be shut down, so you can understand that we are watching our budget very carefully. Still in the mean time, this means that I will be stashing away less money for retirement.

Awful, Awful Fund Choices - Let's put it this way: I don't think that plan administrators could select worse funds if they tried! Pretty much all of the funds are actively managed and are pretty expensive. On top of that, many of the funds selected are simply horrible performers. For example, one of our funds is the Fidelity Aggressive International Fund, with a one year Lipper Ranking of 664 out of 682 funds.... and a 1 (!!) star Morning Star rating. What kind of plan administrator in his right mind would choose this fund?

As if this weren't enough, the funds are all Fidelity funds. Not a single non-Fidelity choice is available. Can you see the finger prints of an unscrupulous sales person and a totally clueless fund administrator? Looks pretty obvious to me.

Very Weak Participation - after inquiring with the current administrator, it appears that only 12 of the company's employees are actually contributing to the company's 401K. with this kind of plan, can you blame them?

Advanced Options - forget about it. No ROTH 401K, no self directed 401K, no opt-out 401K. Nothing. Well, actually, there are a few exceptions: we do have target date funds as well as a "balanced fund" mixing stocks and bonds into a reasonable allocation, and the fund selection does cover all traditional asset classes - except for commodities.

A Shining Ray of Light - the plan includes 2 index funds: the Spartan Total Market Index Fund, tracking the Wilshire 5000 with an expense ratio of 0.1% and a 4 Star Morning Star rating; and an Extended Market Index fund, tracking the Wilshire 4500 with an expense ratio of 0.1% and a 3 Star Morning Star rating.

How I am Allocating My Funds - 70% of the money goes into the Total Market Index Fund. The remaining 30% is evenly split between Fidelity Export and Multinational - the closest I could come to a reasonable international fund (5 Star Rating and a 0.75% expense ratio); Fidelity Real Estate Investment Portfolio (3 Stars & 0.75% expense ratio); and Fidelity Total Bond Fund (4 stars, 0.45%). This asset allocation pains me - since normally I invest at least 30% internationally, but there is simply no viable international option here.

What I am Going to Do About It - I am not one to sit around and do nothing when faced with a crappy, crappy 401K plan. I have every intention to fix this plan. Over the coming weeks and months I will try to insert myself into the plan management team and then will move to implement changes. I will keep you posted.

It just goes to show you how few 401K plans out there are well run, especially at small and medium businesses. The people typically running these plans are administrators or HR persons with little knowledge and even less interest in getting this thing right. At the end of the day, a motivated and well informed employee can do a great deal to improve the situation and to help out his fellow savers. Stay tuned...

401(K) Plan Change - It's Finally Happening

It's finally happening. About 8 months after we launched the process, and about two months after we signed and sealed the official papers, this morning we will be holding the official employee meetings to announce the change of our 401(k) plan.

We are dumping our current plan with ING because of unsatisfactory returns, lack of transparency, high costs and a complete lack of index investing alternatives. Our new plan with ADP will offer very nice bells and whistles, including a wide range of index investment options, as well as highly rated actively managed funds (for those who insist on paying management fees without good reason); a ROTH 401(k) option and even a self managed 401(k) option for those employees that want more control of their financial futures. Even the good people at our finance department have something to grin about - ADP's 401(k) platform is integrated with their pay-roll management services, so there will be much less work for our accounting folks come pay-day.

For me, this day marks a personally satisfying milestone. I initiated the efforts to replace our 401(k) provider and led the search for a new provider, as well as most of the process to this point. So, if things don't work out as planned, my fellow employees are not going to like me very much. Of course, about $50K of my own money is in the plan, so I had a very strong financial incentive to make sure we got the best possible deal. I am just glad to see the train pull out of the station after such a long incubation period (I am also good at mixing metaphors, in case you haven't noticed).

Personal Finance: Intentions & Reality

A couple of days ago I ran across this interesting article. The article outlines the often huge distance between intentions and actions as far as personal finance is concerned. Here is a summary of one section that I thought was especially informative:

Attendees at a retirement planning seminar all claimed that they would be joining their company's 401K plan. In reality, only 14% of un-enrolled seminar participants actually joined the plan. For comparison it should be noted that only 7% of those that did not attend the seminar joined the same plan. This information could lead you to the conclusion that the seminar helped motivate people to take action, however, it could also be argued that there is selection bias at work: i.e. people that chose to attend the seminar did so because they were more serious about taking action regarding their retirement planning. This means that the seminar itself may not have influenced people's actions at all, rather it simply provided a gathering venue for those more serious about retirement planning.

The article also shows that a large majority of people who were already enrolled in their 401K but needed to take certain actions, such as increasing their contribution rate also failed to follow up on their intentions after the seminar.

Here is what I take from this article: people procrastinate. It is in our very nature. We mean well, but our intentions do not always translate into action. Take me for example. I have been meaning to take my car in for an oil change for the past three weeks, but somehow I just can't seem to get it done. I have many good excuses: work has been crazy; my brother is in town for a visit; I have to pick up the kids and so forth. All excellent reasons. Still, no oil change.

What does that mean for people who care about personal finance? A couple of things: first, recognize your tendency to procrastinate, and combat it by building a plan and attaching schedules and goals to it. You want to do something? When are you going to do it? Second, don't develop personal finance plans that require too much activity or that rely on perfect timing. Those would be the most susceptible to procrastination damage.

What does this mean for public policy planners? If you think people are going to plan for their own retirement or make provisions for their long term economic well-being, there is a very strong chance that a majority of the population, while very well intentioned, will never actually get around to doing so. In fact, Congress and regulators are trying to use people's procrastination and laziness as tools to promote healthy retirement savings. One of the ways to achieve this is automatic enrollment of people in their 401K plans. Congress ok'd auto-enrollment in the Pension Protection Act of 2006. Hopefully procrastination now becomes a tool for good, as people who otherwise would never have saved now don't actually get around to opting-out of their retirement plans.

I hope you enjoyed this post. I was actually planning to write it last week, but never got around to it...

The Future of Retirement

The retirement system in the U.S. is broken. This weekend I was reading my copy of Business Week, when I came across an ad on the back cover of the magazine. The full page ad by Allstate was so well-written and to the point that I decided to do an entire post about it. Here are some quotes from the ad and my take on them:

"1. Examine Social Security - Americans will not be able to rely solely on Social Security for a comfortable retirement. In the future, it's projected to cover an increasingly small percentage of the average retirement. There's debate as to whether it should be repaired or replaced. But What's clear is we need to reform Social Security now."

I could not agree more. Where is Congress? Why are we paying those guys to spend all that time in Washington if they cannot be bothered to fix a system that is obviously broken and that many Americans will have to rely upon in their old age? There are about 20 presidential candidates running around the country, both Democrats and Republicans. How many times have you heard them talk about plans for fixing Social Security? Far fewer times than you heard them talk about gay marriage, that's for sure. Why is it that we cannot make our politicians focus on what's important to the vast majority of their constituents?

Here is a sobering statistic. Take a look at the following quote from Wikipedia:

"According to most projections, the Social Security trust fund will begin drawing on its Treasury Notes toward the end of the next decade (around 2018 or 2019), at which time the repayment of these notes will have to be financed from the general fund. At some time thereafter, variously estimated as 2041 (by the Social Security Administration[30]) or 2052 (by the Congressional Budget Office[31]), the Social Security Trust Fund will have exhausted the claim on general revenues that had been built up during the years of surplus. At that point, current Social Security tax receipts would be sufficient to fund 74 or 78% of the promised benefits, according to the two respective projections."

If this information is true, politicians are choosing to ignore this problem knowing that the bad stuff will happen long after most of them leave office. Rule number one of politics: let the next guy deal with the bad stuff.

More from the ad:

"2. Boost Retirement Plan Enrollment. Companies should continue looking for ways to encourage employee participation in 401(k) plans. One proven way to increase retirement savings is through company matches. Another is automatic enrollment - employees are signed up for savings plans when they join the company, unless they specifically opt out."

I completely agree. Especially since Social Security is in such a sorry state, 401(k)'s are extremely important to the financial well-being of Americans. For once, Congress did the right thing in encouraging companies to automatically enroll employees into 401(k) plans, as part of the Pension Protection Act of 2006.

My company is about to move to automatic enrollment, and it is my hope that this encourages the 20% or so of employees who are not yet enrolled, to do so.

Finally, the last quote from the ad:

"3. Increase Personal Savings. Ultimately, everyone is responsible for their own retirement. It's why we support laws that reward people for saving. Tax-advantaged savings vehicles like annuities and IRAs are two examples of products that can help allay Baby Boomers' biggest fear: living to see the well run dry. When planning for retirement, it's time to realize that no one is going to take care of us unless we start taking care of ourselves."

Once again, spot on. Personally, when making our financial plans for retirement I am assuming that the only resources we will have are the ones we save ourselves. We are not counting on a dime from social security, not a nickel from any inheritances, and we are certainly not taking into account any manna from heaven. It's all about our personal savings. That may be too conservative, but my philosophy is that it is better to have too much money saved up than too little. After all, you can always take an extra trip to the South Pacific if you have too much money, but if you have too little you may be planning on dinner for two at Chez Dumpster.

While we should fight to make sure that Congress addresses the Social Security situation, and push companies to become more generous and more diligent in their 401(k) offerings, the ultimate responsibility for your retirement rests with one and only person: you.

So there you go. I never thought I would write a favorable article about a financial ad, but I guess there is a first time for everything.

By the way, to read about how I think the retirement situation can be at least partially fixed, check out this post.

How to Invest Your 401K Funds

In my role as a member of my company's 401K committee, I have recently had conversations about the topic of 401K asset allocation with a number of people in my company. I discovered that people don't really know how to invest their retirement money. Below are some of the poor investment strategies that I have heard about:

Pretend Diversification - one employee told me that his investment strategy is to split his contributions between all available fund options. Since we offer our employees a total of 15 funds, he essentially puts 6.7% of his funds in each of them. What a horrible strategy. Essentially this employee believes that whatever it is we put in front of him is worth spending money on, regardless of cost or performance. That's not diversification, it's laziness. Such laziness makes me want to roll up a newspaper, smack that guy on the nose and yell, "No! Bad investor!" This is probably the second worst 401K investment strategy that I have heard about. Here is the worst:

Putting Your Money in the Safest Investment - one employee puts most of his money in the stable value fund offered in our plan. He thinks he is doing himself a favor by playing it ultra conservative. This is a poor strategy. A 401K is a very long term investment. Arguably it is the longest term investment most people make. That being the case, the daily, monthly and even annual ups and downs of the market are not relevant. All the matters are the long term trends, and in the long run stable value funds barely keep up with inflation. Try to be too conservative with your money and you are bound to end up with a cash stash too small to support you comfortably in retirement.

Over Confidence - more than one employee told me that they are investing their money in only one or two funds. Unless you are talking about a lifestyle fund, or a couple of very broad based index funds, you are probably not going to get the diversification you need from such a small number of funds. You may feel confident about the hotshot international equity fund you picked, but without sufficient diversification you'll be sorry when the next international melt down hits.

Not Paying Enough Attention to Cost - few employees demonstrated to me an understanding of the costs associated with the investments that they picked. That's too bad for them. Costs can have a critical impact on your portfolio. Let me give you an example: let's say that your equity fund generates an average return of 8% a year. If your fund charges an expense ratio of 2%, you are essentially paying a commission of 25% on your profit! And don't think I am exaggerating either. Our 401K plan has more than one fund that carries that expense ratio. That's partly the reason that we are switching 401K plan providers.

So how should you invest your retirement money? Here are a few tips:

1. If You Don't Know Ask - ask your plan's sponsor or call a financial advisor directly. Better yet, go online and read some personal finance blogs for some hints. Go to the library, get a few books and read. Whatever you do, educate yourslef before you commit to any investment strategy.

2. Consider the Costs - very few investment options are worth 2% per year in fees. I am a big proponent of index investing. If your 401K plan offer a broad index fund, check it's expense ratio and consider investing some of your money in that option. Generally speaking, if you are given the choice between two funds that cover the same asset class, you probably want to pick the one with the lower cost. Studies have shown a negative correlation between investment fees and investment returns: the more you pay, the less you get for your payment. What a scheme.

3. Diversify for Real - Don't just select multiple funds. Select funds that cover different asset classes. Get a broad exposure to the domestic stock market, the international stock market and to the bond market. If you can add a small exposure to the real estate market, that might not be a bad option either.

4. Consider Lifestyle Funds - lifestyle funds are an excellent option for investors who feel that they don't know enough to invest for themselves or that don't want to deal with the hassle. All it takes is for you to pick your retirement date, put in your money and the fund invests your assets in a mixture of stocks and bonds that gets progressively more conservative as you age.

5. Stay Out of the Money Market Fund or Stable Value Funds - such funds are great if you are building an emergency cash reserve or saving for your summer vacation, but if your investment time horizon is long, putting your money in such vehicles is a poor decision.

Dislike Your 401K? Join the Club

My first unscientific blog poll closed last week, and here are the results. The simple question I asked my readers was: "Are you happy with your company's 401K?" Of the (measly) 21 votes I received 57% said "yes", while 43% answered "no".

The number of people happy with their 401K plans surprised me. I was expecting a distinct majority of people that would vote against their employers' plans, especially among more engaged investors, a group which is probably over represented in the readership of this blog. Nevertheless, the poll results clearly show that a large minority of workers are unhappy with their employers' plans. Why is that?

As a member of my company's 401K committee, let me take a few educated guesses:

1. Limited Options - many people are unhappy with the type or selection of investment options made available to them in their employer's 401K plan. Whenever the topic of our retirement plan comes up in a discussion with my colleagues, the number one request I get is: "can you add XYZ fund?"

The truth is that employers are unable to accommodate all employee requests in this area. There is a substantial management cost associated with administering the plans, and these costs increase as the number of investment options in the plan goes up. If we were to add every investment option people are asking for, there would be hundreds of different funds in our plan.

In addition, we must also consider those employees that are less comfortable with investing. We find that when such employees are faced with too many choices they either make bad financial decisions, or decide to avoid the issue altogether by not contributing to the plan.

So how do we solve the problem? We offer people a self directed 401K option. You want more options, you got them.

2. Lack of Transparency - OK. Maybe this is just my own pet peeve, but it truly annoys me that even as a member of my company's 401K committee I cannot get a full grasp on the costs our plan participants are incurring. Sadly, the financial institutions that sell and administer these plans go out of their way to make things difficult to understand, and complex to follow. They figure that if you knew the true costs you are paying you may be less inclined to trust your money to them.

So how do we solve the problem? My company is trying to improve the situation by taking the long road towards switching 401K providers - so far, it has taken us eight months (and counting...)

3. Matching - many companies offer only token matching of employee contributions. I have previously worked for a company that did not offer any matching whatsoever. I would not repeat that mistake again today. The nice thing about the match (in addition to the fact that it is free money) is that it goes on top of the employee's $15,500 annual contribution cap. By the way, as far as I am concerned, this is not fair towards those employees whose companies do not offer a match. Why should the government care who is the entity putting the money into the account?

I have previously stated that as far as I am concerned, the 401K system is flawed and should be replaced. I stand by that statement.

Are you unhappy with your company's 401K plan? If so, why?

How Is My 401K Doing?

As I perviously mentioned, EBRI just released their 401K survey for 2006. A couple of days ago I wrote a post about how lifestyle funds are becoming more popular in 401K plans. Today, I want to take stock of my own 401K situation and compare my performance with the data provided in the report.

I joined my company a little over 2 years ago and my current 401K balance is approximately $41,000. According to the EBRI report, my 401K balance is higher than about 65% of plan balances out there. This is where I pause, and pat myself on the back. Now it's time to get a bit more detailed, and compare my balance with that of my peer group.

I am in my mid thirties. Of people in my age group, 29% have less than $10,000 in their 401K accounts; 27% have between $40,000 and $50,000 and 11% have over $100,000. Interestingly, about 0.5% of employees in their 20s have 401K balances in excess of $100,000. Good for them. On the flip side, about 6% of employees in their 60s have account balances under $10,000. I guess some people are simply aching to become Wal-Mart greeters in their golden years.

Of people that have a tenure of 2 to 5 years with their employers, the group into which I fall, about 26% have account balances below $10,000; 15% have balances between $40,000 and $50,000; and about 4% have account balances above $100,000. Folks with 2 to 5 years of tenure who have over $100,000 must have either rolled over an old 401K plan into their current employer's plan; have been contributing aggressively for 4 or 5 years; or have been investing in something on steroids. In any case, good for them. Once again, it is interesting to note that about 8% of employees who have been with their employer for over 20 years still have less than $10,000 in their 401K plans. Repeat after me: "Welcome Wal-Mart Shoppers!".

Finally, according to the report, people in their 30s, who have been with their employers 2 to 5 years have on average $22,368 in their 401K plans. This is my specific peer group, and compared to this group, my 401K is doing spectacularly well. Steady as she goes, then.

To compare your own performance to that of the correct peer group, go to the EBRI report and take a look at figure 13 (page 18).

The Allure of Lifestyle Funds

EBRI has just released its 2006 survey of employee 401K plans. I plan to use a couple of posts this week to review some of the most interesting findings. Today I would like to talk about the topic of balanced or lifestyle funds in 401K plans.

One of the points that come through very clearly in this new report is that more and more employees are opting for lifestyle or other balanced funds. According to the report (figure 33 and figure 34), depending on age group, about 45% - 47% of newly hired employees hold such funds. In addition, in 2006, of those employees that held balanced funds, a large minority (about 40%) held more than 90% of their assets in these funds.

For those of you that are not familiar with the concept of lifestyle funds, these are funds that have a pre-determined allocation of stocks and bonds. This allocation shifts and becomes more conservative as the investor ages.

What is the draw of balanced funds? The greatest asset of lifestyle funds and other balanced funds is that they are simple. They are easy to understand. They are not scary. I mean, let's face it, the vast majority of American workers are not personal finance bloggers, and investing is not a mandatory class in high-school or even college. Many people are scared of investing. They don't know anything about it, and they don't know where to get the information. The promise of the lifestyle fund is the allure of simplicity, and if there is anything people like it's ease of use.

Lifestyle funds, offer investors an easy way to achieve diversification and a reasonable ratio of risk and reward, without requiring them to become master investors. This is a great example of the direction 401K plans should take. While offering more sophisticated options for those us who feel comfortable investing our own money, 401K plans should strive to simplify investing for the average worker. The less scary those plans seem to the novice investor, and especially to young employees, the more people will invest for their retirement and the better off we will be as a society.

So, kudos to whoever invented the lifestyle fund. You are hereby awarded the Shadox Prize of Personal Finance (the "Shpefi"). The Shpefi is slightly more prestigious than the Nobel Prize, however it does not involve any monetary compensation, medals or meetings with royalty. I am working on those aspects of the program, and will keep you posted.

Improving Your Company's 401K

Recently a reader from Tacoma, Washington wrote to me and asked for advice about how to get his company to offer index funds in the company 401K. The sad truth is that many of the 401K plans out there simply suck. I have worked for my share of companies that had miserable fund options, or whose 401K plan had some other major failing. Truth be told, my current company was one of those "401K challenged" corporations.

Shortly after I joined my company (about two and a half years ago) I realized that our 401K plan was not adequate. The first thing I did to address the problem was... nothing. There is nothing worse than joining a new company and immediately creating a name for yourself as a complainer and a trouble maker. Instead, I quietly waited several months for the right opportunity to present itself. In my company, as in many other companies, the group that was responsible for managing the 401K plan was HR. Yes, that makes very little sense. Welcome to corporate America. After a few months of patiently gritting my teeth, I was put in a position to do a favor to our HR director. I took that opportunity to also raise the issue of our 401K plan, and suggest that a few improvements could be made.

To my surprise, our HR Director was enthusiastic that an employee would want to contribute to the running of the plan, and shortly thereafter I found myself on the 401K plan's management team, where I was able to influence the decision making process. As luck would have it, a few months ago my company underwent a restructuring. As part of this restructuring our HR Director left the company and I was asked by our VP of Finance to take a more central role in the management of the plan. That's when I made my move and decided to push for our plan to be completely overhauled. We are now in the process of restructuring our plan401K and are switching plan providers from ING to ADP. This has been a long and laborious process, and it is still going on. In fact, I think that the full process will take another several months to complete.

The point of my story is that if you want your company to make changes to its 401K plan and you have some concrete and constructive advice for making those changes, speak up. I am guessing that much like our own HR group, many human resources folks would be delighted or at least willing to listen to your input.

Regardless, you should also be aware that plan managers are always concerned about being sued by employees unhappy about the company's management of the retirement plan. If for no other reason, plan managers may be willing to listen and act on your advice just to remove you as one potential source of trouble. In short, my advice is to speak up. Do it professionally, do it courteously, but be direct about it, and if necessary, repeat your requests and do so in writing. Eventually, you will probably be heard.

The Best 401K Plans

A few years ago I was interviewing for a position with VISA. The position I was interviewing for was so-so, and in the end I didn't get it. I was told I was over qualified, which I was, but that's a story for another day. I got pretty far along in the interview process, and at one point the HR person discussed compensation and benefits with me. The compensation was nothing to write home about, but the benefits were pretty amazing. At the time, VISA's 401K plan included a 4:1 match up to 6% of salary. To date, these are the best 401K benefits that I have heard of. Recently I interviewed someone who was working for VISA and was thinking of leaving. The person told me that the golden age of the VISA 401K was over and that benefits have been sharply reduced. He did not share the details.

A relative of mine joined Boston Consulting Group after finishing his MBA. When I asked him what the company match to his 401K was, he said that there was none. The company simply contributed the maximum amount permissible to each employee's 401K account. No contribution from the employee was needed. That is the second best 401K plan I have heard of. Of course, the downside to this contribution structure is that the employee doesn't get a chance to contribute even more towards his own retirement plan. Actually, I am not sure whether employees were prevented from adding to the amount contributed by the company. Regardless, we are still talking about a lot of free money.

This is where I open up the floor for discussion and comments. I am asking my readers to tell me about the best 401K plans out there. Let's see if we can create a list of the best retirement plans offered by ordinary employers. Call it the "Best Companies for Future Retirees" list. All viable suggestions will be added to this post with a link to the appropriate blog.

The 401K System Makes No Sense

This is the fifth and final post in my 401K week series. In my previous posts this week I covered everything from ROTH 401K, to company matching funds, to some of the new features in my company’s new 401K plan. However, today I want to take three steps back and make a general comment: the entire 401K system is flawed.

The 401K system creates bad outcomes, discrimination and strange tax consequences. Simply put, the system should be scrapped and rebuilt from the ground up. Here are some of the main problems I see with the 401K system, and how I propose to solve them:

Lack of Expertise – here is the biggest problem with the 401K system: in most companies, and certainly in all the small and mid-sized companies that I have ever worked for, or that my wife has ever worked for, 401K plans are managed by the HR team. With all due respect, the vast majority of HR professionals do not have the first clue about retirement planning, investment options or even basic financial concepts. They view 401K plans as something to be administered while keeping company costs to a minimum.

Concepts such as diversification, return and investment cost reductions are completely foreign to many HR professionals. Many of them are actually afraid of these topics and are paralyzed by their fear. I know very few people who wake up in the morning thinking: “I have some money I would like to invest for retirement. I should talk to a human resources specialist…”, but ironically this is exactly the group that controls a large portion of American’s retirement plans.

Lack of Choice – if your company does not offer a self directed 401K plan, you can invest your retirement assets in only a limited number of often poorly selected and expensive funds. Your company is deciding for you how you may invest your retirement savings. Why is this a good idea? Even if your company offers a self directed 401K 30% of your funds must still go into the company selected funds. The 70% you can invest yourself are, in all likelihood, subject to trading and investment fees that you would probably consider excessive in an online brokerage account.

High Cost – 401K’s are an expensive investment vehicle. The new 401K we are adopting will have an expense ratio of 1.14%. My personal portfolio, built around multiple Vanguard index funds, carries an average expense ratio of around 0.3%. The high cost of 401K plans is one of the reasons we invited a Vanguard representative to bid for our 401K business. However, while Vanguard offered us a fund line-up with an average expense ratio of 0.22%, they also required a plethora of fees that when factored in would increase the cost of the proposed plan to approximately 0.6% - 0.7% of assets per year, and the level of service which they offered us was not adequate for our corporate needs. It seems that even Vanguard, the champion of low cost investing, finds it difficult to offer truly low cost 401K plans.

Needless Complications – 401K plans are subject to a wide range of regulatory requirements and administrative costs. The person that deals with the administration of our 401K plan can be constantly seen running around the corridors with various forms that need to be signed, filed or returned. It’s a mess. That’s one of the reasons 401K plans are so expensive.

Strange Tax Outcomes - Do you find it strange that if your company offers a 401K you can contribute $15,500 this year towards your retirement, while if it doesn’t offer a plan you are basically stuck with the much lower $4,000 contribution level of an IRA? Do you find it amusing that if your household income is above $166,000 per year you cannot contribute to a ROTH IRA, but if your company offers a ROTH 401K you can contribute $15,500 to it, even if you make a cool million every year? What is the justification for such asinine outcomes?

With these and many other problems plaguing the vary concept of company managed, defined contribution retirement plans, I would like to suggest a much simpler, and less expensive option. Hell, this would be good for everyone: employees, companies and government: let’s completely eliminate 401K’s and instead allow everyone to invest the full amount of $15,500 in either a ROTH IRA or a traditional IRA as they choose. Companies could still match employee contributions in exactly the same way, only they would do so by means of direct deposit to the employee’s IRA rather than into a cumbersome and expensive 401K plan.

While we’re at it, let’s allow everyone to make such contributions, whether or not they are employed. Why does it make sense to prevent the unemployed or the under-employed from saving for retirement?

What do you think? Am I making too much sense? Given my “high degree of confidence” in Congress (and the IRS), I am not holding my breath for such common sense changes to occur.

401K Matching: the Pitfalls

This is the fourth post in my 401k week series. Previous posts have dealt with the many features in our new 401K plan; with the concept of a ROTH 401K; and with the reasons we decided to dump ING as our 401k plan provider.

If you are lucky enough to be in a company that matches your 401K contributions, not taking advantage of this free money is practically a crime. Nevertheless, even if you are taking full advantage of the matching, there are a couple of things that you should watch out for:

1. What is being matched? My company matches 50% of the first 6% of pay contributed to our 401K plan. However, matching is only awarded for contributions out of base pay. Bonuses are not matched. Be aware which contributions entitle you to the company match, and make sure you contribute enough to get every free dollar you can.

2. How is matching calculated? My company matches employee contributions on a per-pay-period basis. You only receive matching funds for the first 6% of contribution out of each pay check. This means that if your 401k contribution rate changes throughout the year you may not get the full amount of the match.

For example, an employee who makes $100K per year and wants to max out his contribution at $15,500. If he contributes an even 15.5% of salary per pay period, by the end of the year he will receive company matching of $3,000 (50% match up to the first 6% of salary). However, if the employee wants to max out his contributions by June 30, he will only be getting a total match of $1,500 that year - because contributions in excess of 6% per pay period are not matched. If you are not aware of this and your contribution rate varies over time, you may be leaving money on the table.

This matters especially if you are a new employee joining the company in the middle of the year, or if you are about to quit your job. In fact, this is exactly why this policy is in place. The company wants to ensure that employees are not able to max out their contributions early, get the full match for the year and then quit.

3. Be Aware of Your Vesting Date - most companies that match employee contributions require that the employee work for the company for a certain period of time before the employer match is completely vested. My company has a four year vesting schedule, where 25% of the matched funds vest each year. My wife's vesting schedule is three months - her company matching funds vest at the end of each fiscal quarter.

It is important to know your company's vesting schedule for two reasons. First, if you are thinking about switching jobs, it may be a good idea to time your departure such that it happens after your closest vesting milestone. For example, I vest in 25% of my company match every May. If I wanted to quit my job and were to get a good offer with another company in April, I would try to postpone my departure date by a month to vest in more of my matching funds. Of course, there is no point in missing out on a great career opportunity for a couple of thousand dollars, so use common sense.

It is also worthwhile to check up on your vesting, even if you have no plans to go anywhere. One of my colleagues recently noted that his account did not show a vested match balance, even though he was with the company for two years. When he reported the error, it was corrected within days.

4. Matching in Company Stock - you would expect that after the Enron scandal people would realize that investing large amounts of money in your own company stock was a bad idea. You would also hope that companies would realize that it is not fair to match employee contributions using company stock. No such luck. My wife's company matches her contributions in company stock. On the plus side, since her match vests every quarter, we sell the stock and invest the proceeds in a more diversified investment option. For more about why I think it is a bad idea to invest in your own company stock, check out this post.