Don't Fly Blind When Investing for Retirement
Even when it's tough to do your homework, you can be a well-informed investor.
We've often discussed ways you can make the most out of your retirement plan. One of the biggest considerations--but certainly not the only one--involves choosing the right mix of investments. Because most employer-sponsored plans, such as 401(k)s or 403(b)s, stock their lineups with mutual funds, there's plenty of public information available to research your investment options. After all, mutual funds must disclose their management, holdings, returns, expenses, and other nuggets of data. But what do you do if mutual funds aren't part of your plan?
Instead of mutual funds, many retirement plans include private, separately managed accounts. These offerings feature many of the same advantages as a mutual fund, such as professional money management and easy diversification. But because they aren't registered with the government as public investment companies, they aren't subject to the same sort of disclosure requirements as traditional mutual funds. That can make it difficult for investors to investigate their plans' options.
If that's the boat you're in, don't fret. Below are some strategies you can use when you don't have a lot of information on your retirement plan's investment options.
Make the most of the information you have.
Just because there's not much widely available information doesn't mean you have to fly completely blind. Sadly, too many plan providers give investors woefully inadequate information on their investment options, but they probably have provided some information about strategy and past performance. However, you'll need (and quite frankly, deserve) to know more if you're going to make well-informed decisions. If you can't figure how much the private accounts in your plan charge and who has run them and for how long, call your plan sponsor to find out.
Once you have this information, you can do some basic research. Compare your options' returns (looking especially at longer three-, five-, and 10-year time frames) with those of broad indexes. See how the large-cap options stack up to the S&P 500 Index, for instance, while using the Russell 2000 Index to evaluate the small-cap-focused funds and the Barclays Capital Aggregate Bond Index for bonds. If your plan has super pricey options, you'll probably want to avoid them, as high costs could doom them to underperformance. Ideally, you'll own large caps with annual expense ratios below 1%, small-cap funds with levies below 1.25%, and bond funds charging less than 0.75%. Experienced management is obviously a plus.
See if your investment options have a similar, public counterpart.
Fortunately, you may not have to rely entirely on your plan provider for information. It's often the case that the same people running the private, separately managed accounts in your 401(k) also are in the mutual fund business. In fact, many private funds mirror, or at least pretty closely reflect, publicly available mutual funds. As a result, you might be able to learn more about the private fund in your plan if you're able to hunt down the public offering run by the same manager.
Doing so might be a bit tricky, though. Morningstar.com Premium Members can use the Premium Fund Screener to search by fund manager. (In the screener pull-down menu, select Management and then search under Fund Manager Name.) If the management runs a public fund, you'll see how long they've been at the helm and how their long-term returns stack up against category peers. You may also be able to find out what Morningstar thinks about the fund if it's one of the 2,000 with an Analyst Report.
Stick with index funds.
If your plan includes index funds, you may not have to go through the headache of sifting through opaque disclosures and tracking down the public record of your money manager. If there's a total-market index fund that tracks a benchmark like the Wilshire 5000 or Russell 3000, then you'll get virtually all the domestic-stock exposure you'll need in one fell swoop. Hopefully, there's an international and bond counterpart you can draw upon as well. This option holds a lot of appeal if it's available. It demands far less research, leaves you with a broad, well-diversified portfolio, and doesn't require a lot of maintenance as time goes on.
Diversify and hope for the best.
Many academic studies suggest that investors' returns are more strongly influenced by asset allocation than by the quality of their investment choices. Put another way, how well you do depends more on how much you invest in stocks versus bonds, or in large-cap stocks versus small caps, than whether you've picked good funds. One logical conclusion is that as long as you haven't discovered any red flags in your plan, you can still do well by choosing a diverse blend of options from your investment menu. You want to do so carefully, building a core of stable, solid offerings with more-aggressive investments rounding out your portfolio. (To learn more about core holdings and the role they play in your portfolio, click here.) Don't forget about including a high-quality bond fund in the mix, which helps offset the volatility of stocks in your portfolio.
Create your own retirement plan.
There are plenty of reasons why you should invest for retirement through your 401(k) or other employer-provided retirement plan. There's the obvious tax benefit of doing so; your money grows tax-free, possibly for decades, until retirement. Moreover, because many employers match the contributions you make, skipping out on your 401(k) means you'd be leaving free money on the table.
But if your employer doesn't offer matching contributions and your plan options are too difficult to investigate, it might make sense to think about an alternative retirement savings vehicle, such as a traditional IRA or a Roth IRA, which offer similar tax benefits. (In a Roth IRA, you put in aftertax dollars, which forever grow tax free. By contrast, in a traditional IRA or 401(k), you put in pretax dollars which grow tax free until you begin withdrawing them at age 69 1/2, at which time you have to pay income tax on them.) In an IRA, you can invest in any investment vehicle, including mutual funds and stocks.
Generally, you'll be able to put up to $5,000 per year in an IRA (and another $1,000 if you're over 50), though if you make too much money you may not qualify for a Roth.
If you think your plan is substandard but your employer still provides a match, it makes sense to invest enough to take full advantage of it. Try to choose the plan's best options and then use your IRA to fill in the gaps.
Don't forget about the big picture.
Picking the right investments for your retirement is just one part of a larger picture. Not saving enough (or even worse, not investing at all) and not having a well-thought-out plan will lessen your chances of a secure retirement. (For a longer list of 401(k) pitfalls you should avoid, click here.) In the end, make sure you do your homework on the investment choices in your retirement plan, and don't sabotage your research efforts with big mistakes.
A version of this article appeared on Morningstar.com on Feb. 3, 2009.
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