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The Independent Investor: What Does Your 401(k) Investments Look Like?
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It might surprise you to know that many retirement savers religiously contribute to their tax-deferred savings plans but have no idea what investments they own. Many plan representatives simply suggest that if you don't know, just invest in a target date retirement fund. Is this a good idea?
Most 401(k)s and 403(B)s plans, for example, have between 20 and 30 investment options you can choose from. This menu of choices normally includes bond and stock funds as well as international funds. There are also balanced or blended funds, which invest in a mixture of stocks and bonds. Many plans also have some kind of annuity-like investment as well as target date funds.
Supposedly, target date funds take the thinking out of investing. Let's say you plan to retire in 2040, so you select a target date fund that approximates that year. The rule of thumb states that the closer you get toward retirement, the more conservative one should be. That means you should have more bonds than stocks (according to Modern Portfolio Theory) in your investment portfolio as you age. Each year you draw closer to retirement, the computer model that actually manages these funds simply put more bonds in your portfolio and less stocks.
As a diligent saver who wants to make as much as one can before retirement, let's look at the track record of bonds versus stocks over the last ten years. In this case we have used Vanguard's intermediate term bond fund versus Vanguard's S& P 500 Index fund. But wait, you may say, the last ten years stocks have been up, up and away. So, let's make it 15 years, which includes the worst stock market plunge since the Great Depression. Bonds would have delivered a measly 4.88 percent versus 8.76 percent for stocks. That's almost a double. Over 10 years, stocks gained almost 15 percent.
Let there be no mistake, stocks do hold more risk than bonds. Case in point, in 2008, stocks lost over 35 percent, while bonds delivered investors nearly 5 percent. Fear and greed are motivational issues that govern everything we do in the financial markets. But, let's take a look at bond vs stock returns over the past 10 years.
| 10 Year Returns of $10,000 | ||
|---|---|---|
| Rate of Return | Ending Value | % Gain |
| 4.88% | $16,103.00 | 61.03% |
| 8.76% | $23,157.52 | 131.58% |
Those investors who were able to stomach the declines during the Great Recession were rewarded handsomely over those investors who fled to "safer" bonds. You need to decide the returns that your retirement account requires to reach your goals. Likely, that will mean adding stocks to the portfolio.
Back to the target date funds, a look under the hood reveals that you may own more bonds than you thought.
| JPMorgan SmartRetirement® | ||
|---|---|---|
| Year | Stocks percent | Bonds percent |
| 2020 | 37 percent | 63 percent |
| 2030 | 61 percent | 39 percent |
| 2040 |
76 percent
|
24 percent
|
| 2050 |
83 percent
|
17 percent |
| 2060 | 80 percent | 20 percent |
More bonds will make your retirement account less volatile, thereby giving you a smoother ride towards retirement. The price of that smooth ride will be the length of time it takes before you can comfortably retire. In the case of investing in target date funds, it may mean adding a few more years of working before you get to your destination. Are you OK with that?
Bill Schmick is registered as an investment adviser representative and portfolio manager with Berkshire Money Management (BMM), managing over $400 million for investors in the Berkshires. Bill's forecasts and opinions are purely his own. None of the information presented here should be construed as an endorsement of BMM or a solicitation to become a client of BMM. Direct inquiries to Bill at 1-888-232-6072 (toll free) or email him at Bill@afewdollarsmore.com.
