Tuesday, July 21, 2009

Retirement Planning: The Danger of Opting for Lazy

The Pension Protection Act of 2006, quite possibly the worst piece of retirement legislation to ever take hold, has some employees allowing their employers to do what they are too lazy to do: diversify their accounts, select the right age-appropriate funds and move allocations. Your contribution might stay the same. It is where that money is going that creates long-term and possibly adverse problems for workers who believe they are on the right path.

The PPA is a business-friendly bill that gives employers new abilities. Some of these changes, which can be blamed on a more economical plan for the employer, do not always translate into a better option for the employee.

An employer can look at the cost of their current plan and deem it too costly to maintain. When this decision is made, the funds that were currently chosen by you are shifted into similar types of funds. That is, if you do anything at all.

When there are changes in your plan, you receive notification, often twice before the event. Failure to react to these changes within the given time frame (often thirty days) allows the employer's new plan sponsor to make changes it deems best for your age. The problem with this kind of power is threefold: One - only on the rarest of occasions does the employer have enough information about your finances to make a good decision; two - the new group of mutual funds in the plan may not resemble the allocations you made previously; three - the default options often do not take into account your personal risk tolerance.

In other words, lazy now has a price.

This can have the most devastating effect on younger workers. They often have the poorest understanding of the age appropriateness of their investments. Some have simply under-invested in equities, preferring to avoid what they have witnessed with older co-workers and their parents. In other words, they do not want to lose money. In other words, they are avoiding risk.

Your employer can change that. New plan sponsors can offer to switch funds on you, to allow you greater exposure to equity risk while switching older workers to less risk exposure. They do this by enrolling unsuspecting (although, as I said, notified in advance) employees into target-dated funds.

I have raised suspicions about these types of funds, their ability to perform better than a simple index fund, and the possibility that these funds (more like a fund full of funds from a particular family and not all of them good) will do better over time. Target-dated funds have no track record and more importantly, no guarantee that the manager at the helm will be able to mix and blend the right investments to achieve growth and capital preservation.

Michael Malone, managing director of MJM401k, a 401(k) consulting company in Phoenix suggests that this is still only a possibility. He said, “There is a degree of paternalism associated with it. If we look at the allocations that employees have, there have been more cases than not that those allocations and selections of funds aren’t necessarily the best things for them.” He warns against doing nothing: “But if you want to maintain your existing elections, you can move back into any elections you want.”

The bottom line for any investor, whether they be independent or enrolled in your company's defined contribution plan is to be aware of any shift. While you can change these fund allocations after the fact in many instances, why would you allow the fund sponsor to do the thinking for you.

If your company has a new 401(K) provider with a new group of funds, try to mimic your investments from the previous sponsor's offerings. This may be a bit more difficult because many of the changes are to plans offering less investment options, not more.

But opting to do nothing could cost you thousands of dollars of potential earnings over the course of career.

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