Figuring out the right strategy — and avoiding the wrong ones — when investing for retirement isn’t nearly as complex as investors, advisors and experts want to make it seem.
For most of us, simply putting money in a target-date fund with a low fee will ensure a portfolio grows over the next 30 years.
But there’s so many ways that we get in our own way. Trading too much within a 401(k) or borrowing against a plan can leave a very simple process crumbling into the depths.
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However, there are encouraging trends that investors are getting better at making good decisions with their retirement accounts. The Vanguard Group recently took a look at how members in its defined contribution plans saved in 2015.
We’re borrowing less from 401(k)s. The percentage of respondents with outstanding loans decreased slightly, from 17 percent in 2014 to 16 percent in 2015. The plateau of this trend comes after a few years, particularly from 2010 to 2013, where loan originations jumped.
Jean Young, one of the authors of the reports, says that in past surveys Vanguard asked why people took out loans — about half the time, the answer was paying for home repairs or buying a home. But most advisors would suggest finding another way.
Typically, investors can take a loan out against a 401(k) that’s $50,000 or half of the vested account balance, whichever is less. But if they get laid off or leave their jobs, they have only 60 days to pay back the loan in its entirety or declare the funds as ordinary income on their income tax return, pushing up the tax bill.
Neil Krishnaswamy, a financial advisor at Exencial Wealth Advisors in Plano, Texas, says 401(k) loans can be tempting because of low rates and the simplicity of the transaction — in some cases, loans can be approved in a matter of minutes.
But Krishnaswamy urges investors to keep adding to their 401(k)s while paying back their loans, even if doing both can be a lot for some people to handle.
As a positive, more than over 90 percent of loans are paid back, which indicates that financial problems are at least a short-term issue for most, Young says.
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We’re trading less within our 401k(s). One solid way to lag market returns is to trade often. While many investors like to think they’re adept at timing the market, research proves otherwise. “No one is successful on a long-term basis,” says Jimmy Lee, who runs Wealth Consulting Group in Las Vegas.
That’s why it’s very encouraging to see that only 9 percent of plan participants traded in their accounts last year. This movement toward less trading is positive because investors “usually harm themselves,” Young says. When someone trades often, he or she will trade out of a product too early or too late, and doesn’t capture the gains when the investment reverses.
The increasing popularity of target-date funds has contributed to the reduction of trades. Target-date funds regularly reallocate investors’ portfolios, shifting money into more conservative funds as the target date approaches — a technique designed to minimize risk should the markets suddenly tumble.
“That’s probably a good way to invest for a lot of folks,” Lee says.
Investors have less exposure to their employers’ stock. Some companies include shares of their stock in employee 401(k) plans. While that could be great if the company is having a good year, such an arrangement tends to overweight investors’ portfolios and leaves them vulnerable to sudden misfortune.
In 2010, 31 percent of investors had one-fifth or more of their portfolios tied up in their employers’ stock, according to the Vanguard study. That number dropped to 28 percent in 2015. And the number of companies that offered such a benefit fell from 11 percent to 10 percent.
“One of the good investment principles is minimizing concentration risk, or exposure to one type of investment or asset class in your overall portfolio,” Krishnaswamy says. “By investing in the company stock, you’re magnifying that diversification risk. Concentration risk is usually not rewarded over time.”
This issue is heightened because when financial advisors evaluate a portfolio, they also evaluate their client’s employer. And if the company starts to perform poorly, the stock will suffer.
There are still people without any stock exposure. A concerning number that jumped from the Vanguard study was that 5 percent of plan participants do not invest in any equities. This is a dangerous practice that could leave investors unable to grow accounts large enough by the time they need to tap the funds.
“Most will need to generate some sort of income stream in retirement that keeps growing overtime and keeps up purchasing power over time,” Krishnaswamy says. “Equities are the solution to that problem.”
Investing in stocks, which offer greater returns than bonds, allow investors to build their retirement accounts faster than inflation, which is important when it comes time to pay for their needs in retirement. Such a portfolio is more appropriate once an investor retires, in order to reduce taxes.
[See: 8 of the Most Incredible Investments of the 21st Century.]
“That’s more about when you’ve accumulated wealth,” Lee says. “But when someone’s working, we think it might be better to use tax-deferred accounts to build the wealth you need.”
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3 Things We’re Doing Right With 401(k) Accounts originally appeared on usnews.com
