One of the toughest challenges of being a Financial Advisor comes up all too often. Prospective clients come to us all the time already very close to their target retirement age only to find that they haven’t saved enough in their 401(k) plans or haven’t invested prudently, or worse, both. While financial planning can help make the best of a tough situation, many times the reality is that these clients will have to work longer than they’d prefer. That got me thinking on a few best practices we can offer to people who are currently working and saving in their 401(k)s, to help avoid that outcome of being caught short of savings to support the desired lifestyle during retirement years.
1. Take the long-term outlook (no market timing)
Just a few months ago I had a new client tell me, “The market had been going up steadily since 2009, and I felt really unsure of what was going to happen after the 2016 presidential elections, so I just moved everything to cash late that year.” Roll the clock forward to early 2018, and he’d been sitting on a 401(k) balance that hadn’t grown while the market zoomed. By then, he was even less sure what to do next, and he had changed jobs. While pondering leaving the money in cash in the old plan, rolling it to his new company’s 401(k) and investing it, or seeking out some personalized advice from a CFP® professional Financial Advisor, he called us.
While it was too late to capture the market gains of 2017 for that client, other folks in this situation can save themselves a lot of stress and lost returns over time by taking a long-term perspective, and keeping their 401(k) assets invested in the market regardless of current conditions. All our research points to the same thing: people who market time and try to get in and out based on what’s happening now and what they think is going to happen next perform materially worse over time than people who invest for the long haul. As this is money that won’t be used until retirement, there should be even less anxiety around riding through market downturns.
2. Diversification pays over time
401(k) plan participants often concentrate their portfolios in just one or two high growth positions, or, if they’re employed at a public company, even put a substantial chunk of the balance just in the stock of the company where they work. While a 100% growth equity strategy may be appropriate for some (say, a 25 year-old with high risk tolerance and 40+ years until retirement) for many folks, and especially those who are within 5-10 years of retirement and can less afford a big drop in their balance, getting broad exposure to different asset classes, geographies, and sectors are important for balancing volatility with appreciation potential.
Our research continues to show that superior investment returns can be achieved for any specific amount of risk by diversifying. In particular, choosing an appropriate mix of equities and fixed income (bonds) is important to achieving the right balance between risk and reward. One potential way to get at this issue is by using Target Date Funds. Offered in most 401(k) plan investment menus, these funds are designed to change the mix between asset classes to tilt more conservative the closer one gets to their target retirement age. While not right for everyone, these funds can function as a “set it and forget it” solution for people without significant investment acumen, a risk tolerance that is in line with the average for people their age, and little appetite to actively manage the investments in their 401(k) account.
It’s worth mentioning that at GBB, helping clients with their 401(k) investment decisions, and putting those decisions in the context of their total financial picture and goals for retirement, is a standard service we provide, even though we are not actively managing those 401(k) dollars.
3. Don’t treat your 401(k) like a piggy bank
One of the quickest ways to deplete savings for retirement is to use them up before you retire. While it can be tempting to finance pressing family and personal needs with an in-service distribution or a loan to yourself (pending the particular rules of your company’s 401(k) plan), your future self will thank you for leaving that money to grow and pay for living costs in retirement. Even loans from your 401(k), which you must pay back to replenish your balance, typically carry interest payments, which will reduce your current income. The other practice we see all too commonly is that when people change jobs, they take all or part of the 401(k) balance at their previous employer as a distribution rather than leaving it in a qualified account for later. Almost any kind of distribution taken before the participant turns 59.5 years old will result not only in the application of income tax at both state and federal levels, but also of an additional 10% early withdrawal penalty. There’s no quicker way to knock down the 401(k) investment returns (in real dollar terms) than to reduce the size of your savings balance prematurely.
We regularly assist soon-to-be retirees with their 401(k), among a variety of other financial planning topics. Please give us a call at (916) 269-0671 or complete our contact form to get in touch with a GBB Financial Advisor.