Tuesday, February 3, 2015

401(k) and IRA Performances Are Needlessly Poor for Most Participants ... Why Do We Make It So Hard?

The following article reveals that most 401(k) plan participants seriously underachieve with respect to matching the returns of market averages over a lengthy period of time. In my opinion, such underperformance is unnecessary and easily corrected.

The average annual rates of return of stocks have been substantially greater than that of all other asset classes over the long term. And going forward that will be even more true as interest rates remain relatively low due to a lack of inflation combined with slower than historical economic growth throughout the world.

Investing in a handful of blue chip diversified stocks that pay solid and growing cash dividends will more than compensate for the low interest rates and subpar economic performance that lie ahead.

And what if I'm wrong about the low interest rates and subpar economic growth that I foresee? In that case, stocks will outperform other asset classes by even more. In other words, blue chip stocks offer a heads I win, tails I win scenario for patient long term oriented individual investors.

Now let's see what the referenced article has to say about all this, and then we'll recap in the "Summing Up" section. I disagree with much of what the writer recommends, as you will discover.

Why your 401(k) is lagging the market's gains tells the story:

"A stampeding bull market helped push 401(k) balances higher in 2014, but retirement savers missed most of the fun at this rodeo.

While it’s true that the average 401(k) balance hit a record high of $91,300 in 2014, that figure is just 2% higher than the average balance in 2013, a paltry return compared with the S&P 500’s relatively lofty 13% gain in 2014. . . .

Shaky markets: Get used to it
When trying to assess why retirement savers aren’t matching the market, there are a number of factors to consider. For one, retirement investors generally don’t — and generally shouldn’t be — investing their entire 401(k) account in an S&P 500 index fund.

Even the rare investor who has 100% of his money invested in equities is unlikely to match the performance of the S&P 500 because, while domestic stocks rose, other sectors, including international, energy and precious metals, “have been crushed,” Schatsky said. . . .

Market timing, fees cost 401(k) savers

Another reason 401(k) investors don’t beat the market? Fees. Defined-contribution plans such as 401(k)s “tend to carry higher fees than the best investment choices that are available to individual investors,” Schatsky said.

That’s not always the case. Workers who have access to a large-company retirement plan may enjoy low costs, but employees of smaller companies often aren’t as lucky.

“The reason the fees tend to be somewhat higher is that the owners of the company frequently structure the offering in such a way to minimize the cost to them and to pass on the cost to the employee,” Schatsky said. “That would make even an index fund within a 401(k) underperform most good index funds outside of the 401(k).”

Still, while 401(k) fees, and the media’s penchant for focusing on a particular benchmark, can help paint a dismal picture of investor returns, it’s also true that investors make mistakes that cost them.

One big mistake is trying to time the market. “The average investor underperforms the market because they hold their investments an average of 3.1 years,” Kahler said. That amounts to market timing, he added.

“Research by Dalbar Inc. shows investors who hold investments for over five years tend to receive market return,” he said. “Bottom line, most individual investors make too many decisions about when to go in and when to get out of markets, which negatively impact their returns.”. . .

What now?

The bullish stock market has been running for more than five years. Now’s a good to consider locking in some of your gains.

“After a market has run up significantly over quite a number of years, one would hope you would say, ‘Wow, let’s take some of the money off the table or make it a little bit more conservative,’” Schatsky said.

Your portfolio adjustments “could be driven by concern for the market specifically or driven by a realization that your equity exposure is dramatically higher than you normally would be comfortable with,” he said. . . .

If you haven’t checked lately, there’s a good chance your money is divvied up in a way that contradicts your risk tolerance. “If you’re comfortable with an overall asset allocation of 60% equities [and] you started with that three years ago, you don’t have 60% anymore,” Schatsky said.

For some investors, now might be the time to reduce their exposure to equities and shift their long-term bond portfolio into shorter-term bonds, with an eye on the likelihood of higher interest rates ahead.

But a long-term investor with an appetite for risk might make different decisions. The crux of the matter is to make sure your investments are diversified and match your risk tolerance. Your precise asset allocation will depend on your penchant for risk and other factors.

Some investors, Kahler said, might “look at a 60/40 or 70/30 portfolio consisting of many asset classes including global bonds, high-yield bonds, TIPS, global stocks, commodities, and REITs.”"

Summing Up

My personal 401(k) has been invested DIY style ~100% in American dividend growing blue chip companies for the past several years.

Prior to that, ~100% was invested in the low cost S&P 500 index fund offered by my employer.

I have the time to do my own stock picking and investing now, so that's why I invest in individual stocks. When I didn't have the time to invest in individual stocks, it was the low cost S&P 500 index fund all the way.

I did and still do things this way for several simple reasons: (1) stocks over the long haul outperform all other invest classes; (2) money not paid in fees to financial managers is money that works for me; (3) nobody is a successful market timer; (4) bonds will be lousy investments in a period of rising interest rates, which we will likely have over the next decade or longer; and (5) it helps immensely to understand and internalize the long term wonderful  effects of compound interest and the rule of 72, which recommends that individual investors should start early and stay late.

That's my take, and that's why I do what I do.

Thanks. Bob.

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