Seventeen Steps to Improve Your
401k Returns
by Paul Merriman, President
Merriman Capital Management
The
401(k) plan and for some workers the very similar 403 (b) has become the
primary vehicle for working Americans to save for retirement. But many people
don't take full advantage of this plan, and this will leave them with less
money at retirement than they could have. Here are some steps you can take
to improve your returns.
1. Put more of your investment fund in equities and
less in fixed-income or money-market funds. A few years ago a large financial
institution reported that more than 30 percent of the money in 401(k) plans
was invested in money-market funds or their equivalent. For investors in
or nearing retirement, that may be appropriate. But most workers in their
20s, 30s, and 40s need growth from their retirement investments.
Money-market
funds don't provide growth, only stability. Think of it as money that's
been put "on-hold". Money-market funds have virtually no risk,
so every dollar you put into them will be there whenever you need it. But
over the years, money-market funds can be expected to return only 4 to 5
percent annually. Lately, that has been enough to keep ahead of inflation,
but it hasn't done much more than that.
Over
the years, you can expect equity investments to return at least
11 percent. Over several decades, that difference is overwhelming. If you
invest $833.33 a month (that's $10,000 a year) into a 401(k) plan at 5 percent,
in 30 years it will be worth about $693,549. If the same contributions compounded
at 11 percent instead, after 30 years the account would be worth $2,337,100.
Think
of it this way: At 5 percent, you get back $2.31 for every dollar you invest.
At 11 percent, you get back $7.79 for every dollar you put in.
2. In the equity part of your portfolio, shift some
of your money into funds that invest in small companies. Academic research
indicates that over long periods of time, small-company stocks outperform
large-company stocks. Since 1926, $1 invested in an index of the stocks
of large, relatively mature companies has grown to be worth more than $2,600.
And $1 invested in an index of stocks of smaller public companies has grown
to be worth more than $5,000. Look beyond fund names to determine which
funds in your plan specialize in small companies. You may find this information
in fund descriptions. If it's still not clear, call the administrator of
your 401(k) plan and ask which options fit this category.
Don't put
all your equity portfolio in small-company stocks. But if you have a small-company
fund available, consider investing at least 25 percent of your U.S. equity
investments in that fund.3. In the equity part of your portfolio, shift some
of your money into funds that invest in value companies. These are companies
that for various reasons are regarded as underpriced. If they were goods
at a retail store, they would be called markdowns or clearance items.It
may seem counter-intuitive, but over the years numerous studies have shown
that value stocksthose that are unpopular with investorsoutperform popular
stocks, commonly known as growth stocks. According to data going back to
1964, large U.S. value companies had a compound rate of return of 15.1 percent
vs. only 11.4 percent for large U.S. growth companies. Among small U.S.
companies, the difference was even more striking: a compound return of 17.4
percent for the out of favor value stocks vs. 12.1 percent for the popular
growth stocks. Other studies have shown similar results.You
may have to do some digging to find out whether your plan includes a fund
that specializes in value stocks.The
world "undervalued" in a fund description is a good clue, but
if you have any doubts, check with your plan's administrator or investment
advisor if there is one. You can also go to a public library and look up
the fund's report in Morningstar. A "style box" will have one
darkened square out of nine that indicates if the fund's holdings are weighted
to value, growth or a blend.Don't
put all your equity portfolio into value stocks. But if there's a value
fund available to you, consider investing at least 25 percent of your U.S.
equity investments in that fund.4. Rebalance your portfolio once a year. This assumes
you have an asset allocation plan that calls for a certain percentage to
be invested in each of several kinds of assets. Here's a simple example
that shows the long-term value of rebalancing: Assume you want half your
portfolio in large company stocks and half in small company stocks. Once
a year, exchange assets between the funds to restore that 50/50 balance.
This means you sell some shares in the recent "winner" and buy
shares of the recent "loser". Had you invested equally in indexes
of those two types of stocks from 1926 through 1998 and never rebalanced,
your compound rate of return (CRR) would have been 11.9 percent. Had you
rebalanced every year, your CRR would have been 14.0 percent.That
difference is more significant that it might seem. An investment of $1,000
would have grown in that period to $5,043,199 at 11.9 percent, without rebalancing.
With rebalancing, the same investment would have grown to $22,508,614.Rebalancing
seems counter-intuitive, violating what you may consider to be common sense.
But it restores your asset balance and allows for the possibility that last
year's losers may be this year's winners. In simple terms, it's called buying
low and selling high.If
you don't do this, over the years your portfolio could become seriously
skewed and give you much less of the diversification that you count on for
superior long-term returns. This situation, by diluting your diversification,
actually increases the risk in your portfolio gradually over time; that's
just the opposite of what most investors want and need.5. Persuade the trustees in your plan to add more
options. Specifically, shoot for adding funds that give you meaningful diversification,
such as small-cap stocks, value stocks and international stocks. If you
get a chance to make your case to somebody with the authority to make changes,
prepare yourself ahead of time. You'll find plenty of articles on our site
to document and explain the merits of small-cap stocks and value stocks
as well as worldwide diversification. Even if you don't prevail, your preparation
will be a good education that will help you with your other investments.6. Increase your contribution to the maximum that
you can manage. Many workers contribute just enough to take advantage of
an employer's matching contributions, than they stop. But if you add more
to your account, even without matching contributions, you'll end up with
more in retirement.Even
if you must cut back your current spending, you are not likely to regret
it. Ten years from now, you'll know exactly where those extra dollars are:
working for you. But if you spend the money instead, the chances are slim
that you'll remember where that money went and slimmer still that you'll
be glad you used them for today's needs instead of putting them aside for
your future.7. Ask your parents for help in coming up with the
funds to maximize your 401(k) contributions. You may be surprised at their
willingness to support your long-term investing habits. Giving a child up
to $10,000 per year is an excellent estate-planning tool, and most parents
would rather make a prudent, lasting gift that contributes to a child's
security than a gift that might soon be gone.If
your parents won't go for that plan, try to persuade them to match some
or all of the contributions you make to your plan. If your employer matches
contributions up to 6 percent of your pay, suggest that your parents match
your contributions above that, so you can invest the maximum each year that's
allowed by your plan while you still preserve some of your income for current
needs.8. Invest at the start of each year instead of taking
a little bit out of each paycheck. Nothing in the law says you have to invest
in a 401(k) plan a little at a time, from each paycheck. If you've got some
available cash for living expenses, you can ask your employer to invest
all your pay (or 50 percent of your pay or whatever percentage is workable
for you) until you have reached the maximum allowable 401(k) contribution
for the year. By investing early, you'll put your money to work sooner for
your benefit.9. Without compromising proper asset allocationremember,
that's the most important set of choices you can makeuse the funds in your
plan that have the lowest operating expenses. If the equity funds in your
plan have relatively high annual operating expenses, ask your plan administrator
to add funds with lower ones.Every
one-half of a percentage point you can shave off of operating expenses is
an additional one-half of a percentage point of return. That means the money
is working for you, not a mutual fund company.These
little differences add up to serious money over time. If you contributed
$10,000 a year for 30 years and it compounds at 10 percent, you will wind
up with $1,644,940. If it compounds at 10.5 percent, you'll have $1,808,815.
If you withdrew 8 percent of your retirement nest egg annually, the difference
could mean an extra $13,000 income to you in retirement.10. Choose funds with low turnover in their portfolios,
or persuade your plan administrator to add new funds with low turnover.
This will further reduce your funds' costsand therefore improve your returnin
additional to what you save in lower operating expenses.11. If your plan allows you to exchange your money
among funds without penalty, use market timing for mutual funds for which
you have appropriate mechanical signals. Many plans allow this. Where do
you get signals? For U.S. index funds based on the Standard & Poor's
500 Index, you can use the timing signals available free on our Web site,
www.FundAdvice.com.For
other funds, there's a useful site on the Web: www.bigcharts.com. In the
box at the top of the screen, type in the fund's name or its ticker symbol
if you know it and press the button labeled "Interactive Charting".
If you get a list of funds, choose yours, then either go back and type in
the ticker symbol or choose one of the "go to" options for that
fund. On the left side, click on time frame and choose 3 months; click on
indicators and choose SMA; type 57 in the box next to the SMA choice, then
hit the "draw chart" button. The result is a chart showing the
fund's recent price history and another line showing its 57-day moving average.
If the fund price is above the average, consider that a buy signal; if the
fund price is below the average, consider it a sell signal. Your timing
won't be infallible, and you'll get different results using different averagesanything
from 45 days to 210 days, depending on how frequently you want to trade.
But if you study these charts enough you'll see that in many cases if you
made trades when the two lines crossed, you could often take advantage of
upward moves while protecting yourself from the downside ones.If
you aren't sure about the merits of timing vs. a buy-and-hold approach,
apply timing to half the money in each fund and leave the other half invested
at all times.12. Don't borrow from your 401(k) unless that is the
only way to respond to a life-threatening emergency. It's terribly tempting
for some people to borrow from their retirement funds, but it's much harder
to pay the money back that it is to take it out. And even if you repay it
faithfully, in the meantime you lose that money's ability to work for you.
This is a simple issue, black or white. Just don't do it.13. Don't make early withdrawals from your 401(k)
unless you have to. You'll get the maximum benefit from your plan by keeping
the money working for you as long as possible. Furthermore, if you take
money out before you are 59.5 years old, your withdrawals will be subject
to a 10 percent tax penalty (in addition to regular taxes) unless you are
disabled or you structure the withdrawals over five or more years according
to strict IRS rules.14. Persuade your employer to pay the administrative
costs of operating your plan. These administrative costs, which may be in
the ballpark of $25 to $40 per year per employee, are commonly hidden as
part of the expenses of the mutual funds offered within a 401(k) plan. Some
companies instead pay this fee as an employee benefit. If you can get your
employer to do the same, it will mean more money in your retirement account.15. If your employer allows it, withdraw some of your
401(k) assets and roll them over into an IRA, where you will have almost
unlimited investment options. Relatively few 401(k) plans allow this, and
the exceptions don't advertise it very heavily. But if you can do this,
you'll be able to fine-tune your asset allocation much more effectively
than you can within most 401(k) plans.16. If you leave your job, you'll get a chance to
roll over your 401(k) into an IRA. Take that chance unless your 401(k) plan
gives you investment options you couldn't get elsewhere. In an IRA, you
have the same tax deferral as a 401(k), and you'll have the flexibility
to invest in virtually everything you can get in a 401(k), plus much more.
Some employers' plans will let you make this choice only when you leave
your job; others let you do so any time in the future. Check with your employer
to make sure.17. Here's the most important thing you can do to
maximize your 401(k): Make sure your contributions are automatic, and keep
making them no matter what. That's simple, but it's not easy. Half of the
households in the United States have net worths of $10,000 or less, including
the value of their homes. In a typical year, about two-thirds of U.S. households
do not save money.Many
of the brightest and hardest working people in the country are obsessed
with getting you to spend money and to go into debt, if necessary,
to do so. Virtually all the media that you come in contact with every day
are designed to get you to spend money. In order to save money in this environment,
you will need determination to withstand constant pressures for instant
gratification.We
talk to dozens of investors every week, and we have noticed something very
interesting that seems to separate those who are successful from those who
are not. Most successful investors have a strong personal vision of what
they want and why they want it. That vision gives them the strength to stick
to their strategies even when doing so is uncomfortable. It gives them the
determination to persist when they are discouraged.If
you which to be successful in your 401(k) investments, take the time to
think about the future you want. Create a strong vision, and then don't
let go. The power of a clear, strong vision applies to much more than your
retirement savings. Let your vision shape your life, instead of the other
way around, and a better future can be yours.Editor's
Note: Paul Merriman is considered
one of the nation's top experts on mutual funds and manages over $240 million
for his clients. He is founder and president of Merriman Capital Management
and portfolio of Merriman Mutual Funds. He is also publisher and editor
of FundAdvice.com, 1200 Westlake Ave., N., Ste. 700, Seattle, WA
98109, 1 year, 12 issues, $125, (206) 285-8877 or 1-800-423-4893.