It's not novel or innovative. It's what our parents' advisers told them they should be doing – socking money away in a defined contribution plan so that when their Golden Years arrived, the era's shine would not be dimmed by financial concerns.
But although 401(k) contribution has fallen off somewhat in recent times, advisers need to remind their clients that these plans are still excellent options for retirement saving. The plans just require a few modifications, and some legwork. Here are a few ideas about how to make them better for participants:
1. Education, education, and more education
Surveys show that a lack of finance instruction can have a dramatic adverse impact on 401(k) investment returns. When markets experience downturns, less educated investors tend to panic, move all their investments to cash, and stop contributing to their plans. Of course, prudent investors should do the exact opposite. If their 401(k) provider offers model portfolios, investors should take advantage of the model that's most appropriate, based on their particular length of time until retirement and their appetite for aggressiveness in investing. If their provider does not offer such a portfolio, investors should have their adviser create one, to exercise sound asset allocation. This means shifting money out of bonds and cash into stocks during a downturn, increasing returns in the long run. Investors should also be taught to increase their contributions to make up for the corresponding drop in value. I participate in many 401(k) plan enrollment meetings, and I would estimate that only between 10% and 20% of the participants truly understand asset allocation strategy. This needs to change. 401(k) plans should be paired with mandatory education, and plan administrators should be required to have quarterly meetings between participants and their plan's financial adviser. I would guess that the average 401(k) plan has less than one meeting a year.
Next, do the math -- and think long-term. 401(k) plans are not only about accumulating savings while the participant is working, but the distribution of money during retirement, as well. So, instead of focusing just on contributions, participants should devise a quantitative endgame that facilitates what they want out of retirement. Today's average 30-year-old employee could contribute and distribute money for 60 years or more, and should ask a financial adviser to explain the distribution portion of the plan. If they know what they are trying to achieve and understand the importance of the plan to their future, it will be a lot easier to stick to their goals. We always suggest the same thing to participants: “Work backwards! Start out with how much income you will need in retirement, and then work with the financial professional on the plan to do the math it will take to get there.” I estimate that less than 5% of plan participants do this, and that number should be 100%.
And, the final piece of the education puzzle: Implore investors to stop vilifying the market. We have a country of people who believe that the stock market is bad. We need this to change. Over the last 100 years, stocks have been the best place to invest, and over no 15-year period has the market ever had a net decline. When combined with steady contributions, 401(k) plans, due to their long-term nature, can lead to stable returns in equities. Studies show that since 2008, almost 40% of all 401(k) dollars have been invested in cash or the equivalent. I believe that a 70-year-old worker a week from retirement shouldn't have 40% of his or her defined contribution funds in cash, unless there is a specific short-term need for the money.
2. Improve fund selection.
401(k) plans should be reviewed once a year to make sure the mutual fund lineup being offered to participants is as good as it can be. Financial software available through investment professionals on the plan, can analyze all existing fund choices and help to create a tailored asset allocation model. I estimate less than 5% of plans had their funds analyzed in 2013. Talk about lost opportunities!
3. Lower the plan fee
This might be some advisers' first suggestion, but I believe that plan fees are far less important than finance education and fund selection in maximizing 401(k)'s. Still, plan costs add up, and should be scrutinized once a year along with the choice of funds.
Many plans have extra wrap fees and other expenses that can rob returns from participants over time. The U.S. Department of Labor has done a good job of bringing this issue to light. The ball is now in the court of plan administrators and participants to shop for the best pricing.
Americans' shortfall in saving for retirement is an old story. But when pressed, an estimated 70% of the country's work force will acknowledge that 401(k) plans need to be significantly improved to provide them a better incentive. The good news is that often these plans can be beefed up to provide solid education to their participants, improve their fund lineups and lower their costs.
With these tools, more 401(k) participants will be confident about reaching their goals for a nest egg -- no matter what the size. We need to restore that confidence now, to help prevent a retirement nightmare in the future.
Edward Deicke is a registered representative at JHS Capital Advisors. With more than 20 years of experience, Deicke focuses on helping investors potentially find ways to preserve their assets, increase their income and reduce their income tax.