How to fix your 401(k): if your retirement plan has taken some punishing blows, these remedies can ensure that your golden years aren't tarnished. (Investing).
Amid such a backdrop of uncertainty, millions of Americans evaluated their portfolios. In particular, those who participate in 401(k), 403(b), and similar retirement plans had to make decisions about next year. How much should you contribute and how should you allocate those dollars? Is this the time to pull back, leaving your money in the bank (or even under the mattress), or is this a great buying opportunity, a time to buy stocks for 25% or 30% less than they were selling for two years ago?
BRAVING A NEW WORLD
Shocks and aftershocks shouldn't deter investors, according to several experts interviewed by BLACK ENTERPRISE. "Stay focused on your long-term goals," advises Femi T. Shote, a senior financial planner for Asset Harvest Group in Waltham, Massachusetts. "Based on the performance after previous disasters, markets may rebound in a short time period and wind up even stronger than they were."
Shote points out, "The Dow dropped 4% on the day President [John F.] Kennedy was assassinated, but rallied quickly," adding, "When the threat of the Gulf War emerged, markets fell 6%, but once the conflict began, markets rallied sharply." The years following the crises (1964 and 1991, respectively) were good ones for stocks.
Therefore, investors who hunker down now or flee may be making a mistake. "Attempting to time the market may have a dramatic impact on your returns," says Shore. "Missing just a few days when stocks recover can make a substantial difference in the long term."
FIVE STEPS TO COVER YOUR DOWNSIDE
At year-end 2001, the question for 401(k) investors is whether to be bearish because of short-term fears or bullish about the long-term promise of equities. The answer, for most people, is to seek a happy medium by allocating contributions to both stocks and bonds. How can you keep your balance?
1 Meet your match, If your plan has a company match, put in at least as much as you need to get the maximum employer contribution. "If you don't get the full match, you're giving up part of your pay," says James Herbert Hunt IV, a registered investment advisor in Morristown, New Jersey.
According to Hunt, you should contribute enough to get the maximum match because saving for retirement should be the primary goal, even if you're concerned about paying for your children's education. "When the time comes for them to go to college," he says, "they can borrow any money they might need, but you can't borrow money for your retirement."
2 Make match-less decisions. What if you want to make larger contributions? Next year, the maximum contribution to a 401(k), 403(b), or 457 plan will be $11,000. However, your employer might match, say, only $5,000 or $6,000 of your contribution. Should you max out your 401(k), even if your employer doesn't match some of your contributions?
Some investors are ardent about maxing out. Indeed, Carol N. Brown, an assistant professor at the University of Alabama School of Law, in Tuscaloosa, believes so much in maxing out her retirement funds that she did it twice in 2001. "At the start of the year," she says, "I worked for a law firm that offered a 401(k). I knew I was going to be changing jobs, so I made the full year's contribution ($10,500) by the end of April, to reduce my taxable income."
Then she took a position at the University of Alabama, which has a 403(b), the type of retirement plan offered by nonprofit employers. "I knew I was prohibited from deferring any more pre-tax contributions this year because I had reached the maximum contribution allowed for that tax year," says Brown, "but I wanted to get the employer match, so I contributed my after-tax dollars."
You should consider another type of retirement plan, though, before automatically deciding to max out your 401(k). "After you contribute enough to get the employer match, you might put your next $3,000 into a Both IRA in 2002," says Darric N. Boyd, an associate portfolio manager and financial advisor with the investment firm Legg Mason in Baltimore.
Like regular IRAs, the cap for Both IRA contributions goes up from $2,000 to $3,000 next year, and those over 50 may contribute an extra $500 under the catch-up provision. Contributions to a Both IRA are nondeductible, but all withdrawals are tax-free after five years, provided you're at least 59 years old. Your income can't exceed $95,000 ($150,000 on a joint return) in order to make the full contribution (see "What the New Tax Law Means to You," November 2001).
3 Take an outside chance. Suppose you can save even more, that you can equal the sum your company will match, plus (if you're eligible) contribute $3,000 or $3,500 to a Both IRA? Should you invest this excess inside or outside of a 401(k)? "If you have a weak 401(k), you might be better off investing on the outside," says Hunt. "That's true if your plan has only a few choices or poor performers."
Melvin Carrington Smith Sr., a certified financial planner at First Financial Group in Birmingham, Alabama, says that your tax bracket will make a difference, too. People starting their careers are generally in a lower tax bracket, so they probably won't be able to contribute the full $11,000 to their 401(k)s that's allowable. In this case, money invested above the company match won't amount to much of a tax break; instead, it could be invested in a separate account that can be accessed in the short term with fewer tax consequences. "[Upon retirement], you might wind up paying a higher tax when you take money out, and you'll be vulnerable to a 10% early-withdrawal penalty before age 59. In this situation, after you've earned the employer match and made a Roth IRA contribution, you might do your other investing in a tax-managed or tax-efficient mutual fund," says Smith. Tax-managed mutual funds make a special effort to avoid passing tax consequences on to share holders. For example, if they sell some stocks at a gain, they'll sell other stocks at a corresponding loss.
4 Don't buy what's hot. In 2000 and 2001, the top-performing investments have been bonds, value stocks, and small-company stocks. "Don't load up in these areas," says Boyd. "That's the same trap investors fell into before. Large-company growth stocks did so well in 1998 and 1999 that people invested their 401(k) contributions in those stocks, just when they were overpriced and ready to fall."
Instead, Boyd advocates developing an investment plan, in keeping with your goals and risk tolerance, and sticking to your plan. "Rebalance by making your allocation mix even again. Take from your winners and give to your losers, so you can `rediversify' those areas of your portfolio that are overweighted. This prevents you from taking on a lot of risk," says Boyd.
Often, your allocation will depend upon your age. Young investors, with decades until retirement, may be confident of earning substantial rewards from equities. "I'm not planning to retire for another 20 or 25 years," says Brown. "I expect stocks to have the highest long-term returns, so that's where I'm doing most of my retirement investing."
Even the most aggressive investors, though, should diversify among the types of stocks they own. "Perhaps 10% to 25% of the equities in your 401(k) should be in funds that buy small and midsize companies," says Haywood. Furthermore, advises Elijah A. Faulkner, a financial advisor with American Express Financial Advisors in West Des Moines, Iowa, "Your stock funds should be a mix of value as well as growth issues."
On the other hand, older investors may be better off with a sizable allocation to bonds. "Anyone within five years of retirement needs to be extremely careful," says Shote. "We are in uncharted territory, thus I do not want people who are ready to retire to think they should go on this wild roller-coaster ride."
Haywood says that all the events of the past two years are a signal for investors to go back to a traditional diversified portfolio. "After the bull market of the late 1990s, a lot of people went to all stocks, but you really should hold some bonds, too. Circumstances vary from one investor to another, but you might consider holding 30% of your portfolio in bonds and cash reserves."
Conservative investors might have fixed-income allocations as large as 60%, according to Williams. "In your 401(k), you should hold both government bond funds and corporate bond funds, if these choices are available," he says. "Corporate bond funds tend to be riskier, but they may have higher returns, long-term, so younger investors might want to tilt in that direction."
5 Don't load up on company stock. Many 401(k)s offer investors the chance to purchase company stock while the company match is made in stock. "A lot of people wind up with too much company stock," says Hunt. "If your company runs into trouble, not only might the stock fall, reducing your retirement fund, you might be downsized. That's too much risk to place in one company. Some companies restrict the sale of company stock by 401(k) participants but, if you don't have to keep it, I'd suggest holding no more than 5% of your 401(k) in company stock."
The perils of investing in company stock have become apparent to many 401(k) participants in recent years. For example, James A. Williams Jr. saw his Raytheon (NYSE: RTN) shares decline from around $75 in July 1999 to the $30 level in September of this year, a loss of 60%. Nevertheless, Williams, a director of engineering and product development at Raytheon's Long Beach, California, office, says that he's not nervous about the 25% of his 401(k) that's invested in Raytheon stock.
"I think the stock will recover," he says. "The current international situation may help the company, which produces defense systems and surveillance equipment."
REVIEW THE PERFORMANCE OF YOUR PICKS
For 401(k) investors, deciding to buy stocks or bonds is only the beginning. Investment decisions must be made from among the available selections, which will vary enormously from plan to plan.
Jim Williams, for example, participates in a 401(k) where most of the selections are Fidelity funds. Aside from the 25% he has invested in Raytheon stock, the rest of his 401(k) consists of a 50% allocation to Fidelity Balanced Fund (FBALX) and 25% in Fidelity Equity-Income Fund (FEQIX). "These funds have solid long-term records," he says, "with a mix of stocks and bonds. In 2000, which was a difficult year for stocks, both funds had positive returns."
Haywood, who is Jim Williams' financial planner, intends to go over these selections before the allocation for 2002 is determined. "I'm not comfortable with having a 50% allocation to any one fund, even a balanced fund that holds stocks and bonds," Haywood says. "For next year, I'll probably suggest doing fixed-income investing through bond funds. On the equity side, large-cap value stocks are emphasized by both of the funds he now owns, so there may be better off if he spreads his 401(k) equity allocation among a few more funds, including some with growth stocks and some with small companies."
Therefore, choosing 401(k) investments consists of finding funds that are available within the appropriate investment categories. But you shouldn't blindly pick a fund just because it fits into your asset allocation.
"You should monitor your funds carefully to see how they're performing, relative to other funds of their type," says Alexander Williams. "If they continue to lag in their category or peer group, after a year to 18 months, see if your 401(k) offers a better-performing fund within that category."
Longer term, Hunt says to get rid of a fund that lags its category in three out of five years. "Another warning sign is a change in managers. A new manager may mean a different objective for the fund, and the new direction might not fit in with your overall strategy."
Thus, you should look hard at the funds you're going to entrust with your 401(k) money, and stay vigilant. "Too many people don't know what they have," says Hunt. "They put their money into a fund because they heard about it from a buddy in the next cubicle. That's not a sensible way to build a retirement fund."
Top 20 Equity Funds by Net Assets AVG. ANNUALIZED TOTAL RETURN FUND NAME TICKER 1-YEAR * 3-YEAR * 5-YEAR * Vanguard 500 Index VFINX -23.95 3.55 10.67 Fidelity Magellan ([dagger]) FMAGX -25.29 6.43 10.46 Amer. Funds Inv. Co. Amer. A AIVSX -8.78 9.14 13.24 Amer. Funds Wash, Mutual A AWSHX 3.38 6.87 12.77 Amer. Funds Growth Fund of Amer. A AGTHX -28.42 16.46 16.96 Fidelity Growth & Income FGRIX -15.55 4.94 10.80 Fidelity Contrafund FCNTX -21.03 7.37 10.94 Amer. Funds New Perspective A ANWPX -20.60 10.47 11.26 Amer. Funds EuroPacific Growth A AEPGX -25.64 8.66 6.82 Vanguard Windsor II VVVNFX -0.28 6.12 11.56 Vanguard Institutional Index ([double dagger]) VINIX -23.86 3.66 10.81 Amer. Century Ultra Inv. TWCUX -34.18 3.87 7.98 Janus ([dagger]) JANSX -43.74 4.06 7.95 Vanguard Wellington VWELX 5.52 6.88 10.73 Fidelity Equity-Income FEQIX -8.64 6.52 10.15 Janus Worldwide ([dagger]) JAWWX -40.48 6.34 8.06 Vanguard Primecap VPMCX -29.27 13.78 15.51 Amer. Funds Income Fund of Amer. A AMECX 7.91 6.79 9.86 Fidelity Puritan FPURX -2.91 5.99 9.52 Amer. Funds Fundamental Inv. A ANCFX -18.95 8.18 11.36 NET ASSETS * MIN. INT. FUND NAME TICKER (in billions) INVEST. Vanguard 500 Index VFINX 77.6 $ 3,000 Fidelity Magellan ([dagger]) FMAGX 71.7 2,500 Amer. Funds Inv. Co. Amer. A AIVSX 53.9 250 Amer. Funds Wash, Mutual A AWSHX 48.2 250 Amer. Funds Growth Fund of Amer. A AGTHX 34.3 250 Fidelity Growth & Income FGRIX 32.5 2,500 Fidelity Contrafund FCNTX 30.7 2,500 Amer. Funds New Perspective A ANWPX 28.2 250 Amer. Funds EuroPacific Growth A AEPGX 27.9 250 Vanguard Windsor II VVVNFX 25.1 3,000 Vanguard Institutional Index ([double dagger]) VINIX 24.3 10,000,000 Amer. Century Ultra Inv. TWCUX 24.1 2,500 Janus ([dagger]) JANSX 23.3 2,500 Vanguard Wellington VWELX 22.8 3,000 Fidelity Equity-Income FEQIX 20.2 2,500 Janus Worldwide ([dagger]) JAWWX 20.0 2,500 Vanguard Primecap VPMCX 19.9 25,000 Amer. Funds Income Fund of Amer. A AMECX 19.7 250 Fidelity Puritan FPURX 19.3 2,500 Amer. Funds Fundamental Inv. A ANCFX 19.2 250 FUND NAME TICKER PHONE Vanguard 500 Index VFINX 800-662-7447 Fidelity Magellan ([dagger]) FMAGX N/A Amer. Funds Inv. Co. Amer. A AIVSX 800-421-4120 Amer. Funds Wash, Mutual A AWSHX 800-421-4120 Amer. Funds Growth Fund of Amer. A AGTHX 800-421-4120 Fidelity Growth & Income FGRIX 800-544-6666 Fidelity Contrafund FCNTX 800-544-6666 Amer. Funds New Perspective A ANWPX 800-421-4120 Amer. Funds EuroPacific Growth A AEPGX 800-421-4120 Vanguard Windsor II VVVNFX 800-662-7447 Vanguard Institutional Index ([double dagger]) VINIX N/A Amer. Century Ultra Inv. TWCUX 800-345-2021 Janus ([dagger]) JANSX N/A Vanguard Wellington VWELX 800-662-7447 Fidelity Equity-Income FEQIX 800-544-6666 Janus Worldwide ([dagger]) JAWWX N/A Vanguard Primecap VPMCX 800-662-7447 Amer. Funds Income Fund of Amer. A AMECX 800-421-4120 Fidelity Puritan FPURX 800-544-6666 Amer. Funds Fundamental Inv. A ANCFX 800-421-4120 * As of September 30. 2001 ([dagger]) Closed to new investors ([double dagger]) Institutional funds, not open for retail sales Source: Morningstar Inc. Top 20 Fixed-Income Funds by Net Assets AVG. ANNUALIZED TOTAL RETURN FUND NAME TICKER 1-YEAR * 3-YEAR * PIMCO Total Return Instl ([dagger]) PTTRX 15.41 7.03 Vanguard GNMA VFIIX 11.94 6.77 Vanguard Total Bond Mkt Index VBMFX 13.34 6.30 Franklin CA Tax-Free Income A FKTFX 10.56 4.64 Amer. Funds Bond Fund of Amer. A ABNDX 8.05 5.25 Franklin U.S. Government Secs A FKUSX 11.99 6.45 PIMCO Total Return Admin ([dagger]) PTRAX 15.15 6.77 Vanguard Short-Term Corp. VFSTX 10.78 6.6 Vanguard Interm-Term Tax-Ex VWITX 9.86 5.1 Franklin Federal Tax-Free Income A FKTIX 9.53 4.29 Vanguard High-Yield Corporate VWEHX -4.30 0.97 Vanguard Total Bond Mkt Index Instl ([dagger]) VBTIX 13.47 6.42 AXP High-Yield Tax-Exempt A INHYX 9.04 4.01 Franklin High-Yield Tax-Free Inc A FRHIX 8.15 2.68 Fidelity Spartan Municipal Income FHIGX 11.91 5.28 Fidelity Intermediate Bond FTHRX 12.81 6.45 Franklin NY Tax-Free Income A FNYTX 9.75 4.57 Morgan Stan Inst Fixed-Income ([dagger]) MPFIX 13.41 6.49 Morgan Stanley U.S. Govt Secs B USGBX 11.84 5.79 Rochester Fund Municipals A RMUNX 10.77 3.93 AVG. ANNUALIZED TOTAL RETURN FUND NAME 5-YEAR * PIMCO Total Return Instl ([dagger]) 8.88 Vanguard GNMA 7.85 Vanguard Total Bond Mkt Index 7.98 Franklin CA Tax-Free Income A 6.28 Amer. Funds Bond Fund of Amer. A 6.30 Franklin U.S. Government Secs A 7.51 PIMCO Total Return Admin ([dagger]) 8.61 Vanguard Short-Term Corp. 7.01 Vanguard Interm-Term Tax-Ex 5.98 Franklin Federal Tax-Free Income A 5.92 Vanguard High-Yield Corporate 4.20 Vanguard Total Bond Mkt Index Instl ([dagger]) 8.10 AXP High-Yield Tax-Exempt A 5.77 Franklin High-Yield Tax-Free Inc A 5.31 Fidelity Spartan Municipal Income 6.77 Fidelity Intermediate Bond 7.31 Franklin NY Tax-Free Income A 6.32 Morgan Stan Inst Fixed-Income ([dagger]) 7.75 Morgan Stanley U.S. Govt Secs B 7.14 Rochester Fund Municipals A 6.28 NET ASSETS * MIN. INIT. FUND NAME (in billions) INVEST. PIMCO Total Return Instl ([dagger]) 33.9 5,000,000 Vanguard GNMA 14.4 3,000 Vanguard Total Bond Mkt Index 13.6 3,000 Franklin CA Tax-Free Income A 13.3 1,000 Amer. Funds Bond Fund of Amer. A 10.8 250 Franklin U.S. Government Secs A 7.2 1,000 PIMCO Total Return Admin ([dagger]) 7.0 5,000,000 Vanguard Short-Term Corp. 7.0 3,000 Vanguard Interm-Term Tax-Ex 6.9 3,000 Franklin Federal Tax-Free Income A 6.7 1,000 Vanguard High-Yield Corporate 6.1 3,000 Vanguard Total Bond Mkt Index Instl ([dagger]) 5.5 10,000,000 AXP High-Yield Tax-Exempt A 4.7 2,000 Franklin High-Yield Tax-Free Inc A 4.7 1,000 Fidelity Spartan Municipal Income 4.7 10,000 Fidelity Intermediate Bond 4.6 2,500 Franklin NY Tax-Free Income A 4.6 1,000 Morgan Stan Inst Fixed-Income ([dagger]) 4.2 5,000,000 Morgan Stanley U.S. Govt Secs B 4.2 1,000 Rochester Fund Municipals A 4.1 1,000 FUND NAME PHONE PIMCO Total Return Instl ([dagger]) N/A Vanguard GNMA 800-662-7447 Vanguard Total Bond Mkt Index 800-662-7447 Franklin CA Tax-Free Income A 800-342-5236 Amer. Funds Bond Fund of Amer. A 800-421-4120 Franklin U.S. Government Secs A 800-342-5236 PIMCO Total Return Admin ([dagger]) N/A Vanguard Short-Term Corp. 800-662-7447 Vanguard Interm-Term Tax-Ex 800-662-7447 Franklin Federal Tax-Free Income A 800-342-5236 Vanguard High-Yield Corporate 800-662-7447 Vanguard Total Bond Mkt Index Instl ([dagger]) N/A AXP High-Yield Tax-Exempt A 800-328-8300 Franklin High-Yield Tax-Free Inc A 800-342-5236 Fidelity Spartan Municipal Income 800-544-6666 Fidelity Intermediate Bond 800-544-6666 Franklin NY Tax-Free Income A 800-342-5236 Morgan Stan Inst Fixed-Income ([dagger]) N/A Morgan Stanley U.S. Govt Secs B 800-869-3863 Rochester Fund Municipals A 716-383-1300 * As of September 30, 2001 ([dagger]) Institutional funds not open for retail sales Source: Morningstar Inc.
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|Author:||Korn, Donald Jay|
|Date:||Dec 1, 2001|
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