5 Surprisingly Easy Ways to Overhaul Your 401(k)
Updated: August 27, 2012
If you haven't thought about the performance of your 401(k) in awhile, you're not alone. Most Americans have been neglecting their retirement plans.
According to a 2012 Employee Benefit Research Institute survey, 23% of workers feel "not at all confident" about having enough money for a comfortable retirement.
The facts are scary, but they won't improve until people start taking charge of their retirement plans.
Read on to learn how you can make sense of your 401(k) plan quarterly statement, smooth out the rough edges of your plan and get back on track to earning solid returns all the way to retirement.
Compare Your 401(k) Performance to the Market
The first thing you'll see on your 401(k) statement is the year-to-date (YTD) and quarterly performance. It may be a relief that you made some return on your money, but is your 401(k) keeping up with the market?
If the majority of your portfolio is comprised of U.S. stock mutual funds, compare your 401(k)'s YTD and quarterly returns to the S&P 500 index (which is usually posted on your 401(k) statement, but if not, is readily available online at Google Finance or other financial sites).
The S&P 500 index lost about 3% in Q2 2012 but it has gained 12% YTD (as of 8/27/2012). If your portfolio managed to beat the market over these periods, you did better than most mutual fund managers.
But a good quarter or six-month period doesn't your 401(k) plan is set. The most successful investors review their portfolio mix at least once a year.
Have the Right 401(k) Portfolio Mix
Follow your suggested allocation model (found in your 401(k) introduction packet) if you're not using a target date fund. If the current allocation percentage of any asset class is off by more than 5% from your suggested allocation model, then it's time to rebalance your portfolio.
If it's been more than five or 10 years since you've changed the investment mix in your 401(k), talk to an investment advisor or your company's human resources advisor to establish a new allocation model. After all, your time horizon before retirement has changed, and so should your portfolio model.
Remember, you don't want to be overexposed to any one asset class. The hot asset class of today may have grown in your portfolio, but the cold asset class may not stay cold during the next few months or years. By rebalancing your portfolio, you are selling off overpriced "hot" asset classes and buying more of the undervalued asset classes at a discount.
Managed Funds for Index Funds
If your 401(k) plan offers them, switch to index mutual funds that mirror the market rather than managed mutual funds that charge you higher fees. The average managed fund has an expense ratio of 1.47%, or seven times that of most S&P 500 index funds. Making the switch now to a low-fee index fund can save you tens of thousands of dollars in the long run.
Also keep in mind that most professional fund managers find it hard to consistently beat the market. Standard and Poor's (S&P) reports that over the past five years more than 50% of active fund managers failed to beat benchmark indexes. If the best in the business can't do it, how can you?
Keep the Good Funds, Lose the Bad Ones
If your 401(k) doesn't allow index funds as part of your plan, or you simply prefer managed funds, be sure to put them to the test. Compare the YTD, three-year, five-year and 10-year performance of the fund to an index benchmark. You can compare domestic stock funds to the S&P 500 index, foreign stock funds to the S&P Global 1200 Index and bond funds to the Barclays Capital Aggregate Bond Index.
If the performance of a large-cap fund, for instance, has consistently lagged when compared to the S&P 500 index, try another large-cap fund offered in the 401(k) plan and see if it has performed better over previous years.
While you're researching your managed funds, make sure the fund hasn't recently changed managers -- otherwise, the long-term performance doesn't anything.
If you have the fund symbol ready, you can easily research managed funds and their manager information at the Yahoo Finance Mutual Funds Center.
If your research shows that the funds in a given asset class are underperforming, switch to the one that has the best returns and lowest expense fees. Do this for every asset class to get the best results.
Consolidate Your Old 401(k) Plans
If you have any older 401(k) plans that you haven't moved from a previous employer, now's the time to consolidate those old accounts into one plan.
Having just one 401(k) plan will keep your investments organized and make them easier to track, saving you time and money. If you thought researching 10 funds in one 401(k) was bad, imagine how long you would spend researching all the funds in several plans. Not to mention that a lot of firms that hold old 401(k) plans charge a "custodial fee" just to keep the account open.
Do yourself a favor and consolidate plans to save time on next year's review.
The Investing Answer: According to Frank Satterthwaite, an executive at Vanguard Investments, 90% of a portfolio's return depends on the proper asset allocation.
Do your homework and get rid of the underperforming funds that are dragging down your portfolio. Also, consolidate all of your plans to get your 401(k) back into fighting shape. With your continued contributions to your plan, a lean and mean 401(k) portfolio can lead to solid gains and a more comfortable retirement.