Investors sizing up realistic 401(k) expectations: participants shy away from short-term strategies. (Special Report: Finance).

When reviewing returns on the investments in a 401(k) plan, some people may be disappointed if they don't see the kind of double-digit gains some investments in the stock market have been returning over the past few years.

You might be wishing your employer would add some investment choices representing market sectors such as technology or health care.

You're not alone. In February. telephone interviews were conducted with a nationally representative sample of 402 participants in employer-sponsored 401(k) retirement plans. The average age of respondents was 45; all had household incomes of $75,000 or greater and 65 percent were college educated. Median plan assets were $60,000. and 75 percent of respondents had been participating in a plan for more than five years.

Many participants expressed interest in having certain types of investment choices made available to them, particularly in fund categories that have been performing well in recent months including technology and other sector funds, large cap funds and broad market indexes.

The desire to chase the latest hot performers is understandable. But it may not be the best strategy, particularly for retirement investing. Attempting to catch investments at just the right time is a short-term strategy that can jeopardize your returns over time.

* What 401(k) Plan

Participants Want

The market's performance over the past few years has turned 40 1(k) participants into fairly active investors - half of the respondents in our survey said they had reviewed their asset allocation mix in the past month, and 25 percent said they reviewed their investments once a month or more. More than half said they had made a change in their investment allocation in the past year.

While plan participants may be actively involved in making their own investment decisions, they may not be making choices consistent with the long-term nature of retirement investing. Plan participants were most interested in adding fund types that have had strong short-term performance and publicity: sector funds (37 percent) and sector index funds (18 percent), large cap funds (23 percent) and broad market indexes (21 percent).

And, changes in investment selections were most often made in reaction to market conditions - no more than 20 percent of participants said they made changes as a result of plan information or adviser recommendations.

Expectations have also clearly been conditioned by recent investment experience. Over the next five years, seven out of 10 respondents said they expected their account returns to equal or exceed their 1999 returns, which they reported averaged 21 percent.

* Facing Up

To Reality

These expectations for continued high returns may be unrealistic. It's true that over the last five years, U.S. stocks as measured by the S&P 500 composite index have returned an average of 28.16 percent.

Over the last 10 years, however, the average annual return has been a lower 18.25 percent. When considering an even longer period of time, returns drop even more -over the last 80 years, the average annual return has been 13.09 percent.

When you're tempted to jump into an investment that's currently hot - whether stocks, bonds or cash - consider this: Attempts to time the market can be disastrous. Take a $1 investment made in the stock market over a 20-year time period from 1978 to 1998. That $1, if invested in stocks, would be worth $26.24 after 20 years. But if our hypothetical investor missed the best 15 months of trading while jumping in and out of the market, that $1 investment would, be worth just $6.67.

If the same illustration is stretched out to represent the market from 1925 to 1998, a $1 investment in the broad stock market would be worth $2,351. But if our investor missed the best 40 months of trading, the $1 investment would be worth just $14.10.

In fact, if the investor had stayed out of the market altogether and invested only in cash and cash equivalents like money market funds, he or she would have made out better, holding an investment worth $14.94.

* Size Up

Expectations

Increasingly, 40 1(k) plans are a major part of many Americans' plans for the future - on average, respondents in the survey held close to half of their households' investable assets in their 401(k) accounts. In a survey last year, the Employee Benefit Research Institute found that the average 401(k) account balance was over $37,000 - an average that rose to more than $87,000 for older plan participants.

To avoid having unreasonable expectations of your 401(k) plan, you should remain focused on long-term asset allocation strategies. If a plan has a broad selection of funds, you can establish and maintain a well-conceived asset allocation strategy that suits your investment goals and time frames, and your risk tolerance.

While holding a mix of stocks, bonds and cash may not sound as exciting as chasing the latest hot stocks, it can be more rewarding over the long term. Having a diversified portfolio can cushion the effects of market volatility and enhance total returns.

Balancing the stock portion of a portfolio between stocks of different types, such as small and large capitalization stocks or domestic and international stocks, is a part of diversifying. Simply by participating in a 401(k) plan, you can also take advantage of another proven investing strategy, that of dollar cost averaging.

By investing the same dollar amount on a periodic basis in the same security, as you do in a 401(k) plan, you automatically buy more shares when prices are down and fewer shares when prices are high. Over time, you may be able to lower your average cost per share, which can boost your overall investment returns. (Dollar cost averaging cannot guarantee a profit or protect against losses.)

Your 401(k) account may represent a major factor in your retirement planning. Talk with your financial consultant about how you can invest within your 40 1(k) account in a way that will help you reach your retirement goals.

Coghlan is first vice president, wealth management adviser and certified financial manager for the Downtown San Diego branch of Merrill Lynch.