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401(k)s Are For Saving, NOT Investing

This article is more than 10 years old.

The reality is 401(k)s aren’t designed for investing, they’re designed for saving.  This is important for those with a large retirement account balance with an employer because this precious asset is being held hostage with no room for negotiation.

Recently, I met with a couple who are diligent savers.  They’re professionals just shy of age 50 and have accumulated nearly $1 million inside their 401(k)s.  An impressive feat considering the recent recession and the fact that 401(k)s are less than 30 years old.

However, after reviewing their holdings they were horrified when I told them that their 401(k) investment options were some of the worst I had ever seen.  Between their two Fortune 500 company plans, with 50 different investment options, there was literally only one fund that I’ve recommended over the past year to clients.

Typically 401(k) participants are limited to 20-25 choices that are bloated with middle-of-the-pack large cap funds, balanced funds, and target-date funds that lack transparency.  Rarely do you see enough fixed-income options to diversify among bond maturity or credit quality, much less important asset classes such as precious metals, emerging markets, or specific country options that can be safe havens during times of political nonsense.

All told, managing a large 401(k) account balance is becoming a major issue for investors.  They’re being forced to manage their life savings without the tools and resources they need … and it will only get worse if investors fail to take a more active approach with their accounts.

So what can people in this situation do?  Outside of complaining, I suggest calling your HR department or plan administrator and ask if your plan has an in-service transfer option.  Many companies don’t, but you may have the option of rolling over all or some portion of your 401(k) to a self-directed IRA without retiring or quitting your job (commonly referred to as separating from service).

This can be a great way to diversify your holdings and add investments that aren’t commonly found in employer plans.  However, make sure you have a solid strategy before you make the move because you won’ be able to move them back.  Furthermore, don’t ever use this option to buy a variable annuity.  You’re 401(k) is already tax deferred so any professional who suggests this strategy is benefiting more than you are, while at the same time, limiting your access to it.

A second option for savvy savers with a lackluster 401(k) is to differentiate the way you manage your contributions and existing account balances.  If you’re getting close to retirement or just want to be more conservative allocate a higher percentage of your funds to value-based investments (large, mid, and small cap value).  Historically speaking, value investments are less volatile than growth investments because they tend to invest in older, more established companies that pay a dividend instead of being focused on whatever the newest thing is.

Then consider directing a portion of your regular contributions toward more aggressive and out-of-favor investments.  Let me explain:  by using your regular contributions to invest in areas of the economy that are out of favor you can continually buy low for as long as that sector underperforms.  Then as that underperformer begins to recover, you can shift those contributions to another area, continually buying low while allowing the shares you bought dirt cheap to rise.

Where is underperformance happening now?  There has been some continued weakness in financials, small cap growth, and emerging markets.  These sectors are definitely on sale but also come with some added risk.  So steer clear of putting what you have already saved into these areas, and instead use small contribution over time to maximize your 401(k)s return.

The reality of 401(k)s is that they were originally designed for saving instead of large scale investing.  Too many plans and their investment options handicap good savers; but don’t despair.  With a little creativity and effort, savvy savers can come out on top.