Like most elements of personal financial planning, your 401(k) account requires ongoing attention and adjustments. Most 401(k) account owners from day one do not allocate their investments in an optimum allocation that will give them the best returns. Even those that do manage to allocate their 401(k) assets wisely; they don't re-balance annually and/or are blindsided by minor and major changes in their 401(k) months or even years after the changes were implemented. In the utter busy-ness of our lives, it is easy to miss the announcements from HR on 401(k) plan changes.Finally, the most serious harm to our 401(k) growth is psychological - the so-called behavior gap which I have blogged about many times as it cannot be over-emphasized. I will address these issues one at a time and I also have graphs to illustrate how these problems can impact you financially in hypothetical scenarios.The first set of problems involve oversight and maintenance. Examples are:
- Failure to re-balance annually. Annually is an adequate frequency. However, if larger than normal swings have occurred since the last re-balance - then an extra re-balance is helpful since the re-balance accomplishes "selling high, buying low". This gives an extra boost in returns over time.
- Failure to notice new funds being added and/or subtracted - and the subsequent re-design of your asset allocation. Asset allocation is a fancy term for the percent of assets you place in each fund. The plan may decide new allocations for you and even though they do a great job of attempting to inform you - in the chaos of life and flurry of information being flung at you - it is easily missed.
- Failure to notice and take action when you get an entirely new plan. You will get placed into a default fund(s) that may not be awful, but is probably not optimum. At that time you need get a complete list of fund names and ticker symbols to your investment advisor so that they can create the best possible portfolio from the options provided. (They need the ticker symbols to make informed choices and interestingly, the ticker symbols are not always readily available. Be persistent!)
To illustrate the financial impact of these kinds of issues taking place over 30 years in a 401(k) - we created a scenario with the following assumptions: 1) two investors saved $10K/year in their 401(k), 2) Investor 1 stayed on top of their 401(k) annually, Investor 2 did not. 3) As a result, Investor 1 earned 9% each year and Investor 2 has 5 years at 7% return, 5 years at 9% return and alternates back and forth each 5 years, based on letting her 401k get out of sorts, before getting back on top of it again. The result is that Investor 1 finished with $1.37M and Investor 2 with $1.17M. Investor 2's final amount is 18% short of where it could have been with just over $200,000 less than Investor 1. In my humble opinion, this scenario understates reality - perhaps significantly.As much impact is $200,000 less in retirement, how about $762,000 less?The Behavior Gap - so critical to avoid this "Gap" - yet it is occurring everyday to very smart people with advanced degrees and years of success in their careers. The flames that cause the Behavior Gap are fanned everyday by the financial press and by sellers of financial products. The Behavior Gap describes the difference between what people actually earn vs. the S&P500 Index. The idea is that anyone who invests in stocks could and should easily get the return of the S&P500 Index. Yet Dalbar documents (each year) that those investing in stocks only get one-fourth to one-half of the S&P500 return - this the Behavior Gap. That is a huge gap especially when you consider that investing is an adventure in compounding over time. Here's the Dalbar Chart:
And, yes, the Behavior Gap runs rampant in 401(k) plans. A very obvious indicator is the "Stable Value Funds" that are placed into 401(k) plans. By investing in these funds, you are directed away from stocks which is how wealth is best built over time. Stable Value funds lure more individuals into the destructive Behavior Gap. Stable Value sounds great - some marketing person should be getting paid handsomely for coming up with that very comforting name "Stable Value".In my opinion, Stable Value funds should be banned from 401(k) plans. I regularly see 401(k) plans that have one-tenth or more of the total plan dollars placed into those funds! That is awful and wrong!To illustrate the Behavior Gap, we assumed that Investor 2 earns half of the 9% (4.5%) which is at the more positive end of the range. In this Behavior Gap scenario, the 401(k) investor ends up at $611,000 versus $1,370,000 - a gap of about $760,000. Another way to say it is that you could have had 125% more if you could have avoided the Behavior Gap.Below plotted on one chart is all three scenarios. This clearly shows that the Behavior Gap is more destructive to your retirement readiness than neglecting it - and both will harm you significantly. Get it invested properly with the expertise of a prudent investment advisor, re-balance it annually and stay on top of it, especially fund changes.