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The secret is revealed at the end.
TIME VALUE OF MONEY, asset class, diversification, dollar-cost averaging: This is the language of investment professionals. But it isn’t the language of everyday Americans, including those saving for retirement in their employer’s 401(k) plan.
Trust me, I know. During my nearly 30 years overseeing 401(k) plans, including providing financial education to participants, it became clear to me that using such plans as intended wasn’t easy for most people.
For diversification, employees would often invest in several different mutual funds all focused on a similar collection of U.S. stocks—with no thought of adding bonds or foreign shares. In many cases, workers couldn’t be dissuaded from putting all their money in their employer’s stock. When target-date funds were added to a plan’s menu of investment options, many participants bought them as one of several investments, thereby negating the intended purpose.
During the 2008-09 financial crisis, employees often panicked, even if retirement was decades away. Needless to say, this locked in losses and meant they missed out on the subsequent recovery. Even worse, some workers were turned off investing in stocks and instead retreated to bond funds and other-fixed income options, in the process likely making their retirement-income goal impossible to achieve.
Participants consistently displayed a tendency to be ultra-conservative or dangerously risky with their investments. In either case, they put their retirement in jeopardy. It was rare that employees adjusted their investment mix as retirement approached. Many focused on their retirement date as if, on that date, they would use all the money in their account, thereby missing the vital point of allocating their investments to maximize an income stream over what could be 20 years or more. All these missteps were common, despite extensive and ongoing efforts to educate plan participants.
The reality: Workers can be overwhelmed by the choices they’re required to make—and by the consequences of making wrong choices. This is often compounded by employers adding too many investment options, which leads to indecision or throwing a dart at several funds with nice sounding names. One plan I reviewed for a friend offered 42 different mutual funds. That friend, not understanding the differences among the funds, chose none and instead defaulted to a fixed-income fund. Result? He retired with $45,000 in his account.
For most Americans, 401(k) plans are the most important retirement savings vehicle available to them, especially so when there’s an employer match. And yet these plans won’t provide a secure retirement if used incorrectly. Getting workers to save is the first step. Teaching them to invest is the second.
We have a long way to go.
This was my first article for HumbleDollar in 2018.
Ahhhh Sir Richard… So cool the last line.
My last job had a fantastic pension for decades. It got overwhelmed and in 2011 was modified, but still was a pension.
3 years ago after I retired, grandfathering the pensions, they went to the 401K option and I am wondering now just what options the participants have, and what they are doing with them.
I worked in the investment biz and one year was a part of the employee benefits communications team for our company’s 401K plan. While I generally knew that too many employees were too conservative in their investment choices, I was appalled when I spoke to individual employees about their plan choices. The number who were entirely invested in the cash option and their reasons why (safety) was revealing. Not only did many employees not understand the basic concept of the time value of money, our company had utterly failed to help its employees understand this concept in order to make better long term investment choices.
Save early and save often are just the starting steps to successful investing. People also need to understand that a reasonable exposure is their only sure way of growing their savings on an inflation adjusted basis.
Right you are.