Fun On The Train!

401k/403b Plans Set Up To Fail

What 401k/403b Plan Participants Can't See & Why It's So Dangerous

                                                                                by: Brendan Magee

I'll admit it. Once in a while for fun, I like to watch the Three Stooges. I especially like it when one of the Stooges covers up a hole in the floor and some unsuspecting character steps on the rug and falls through the floor. Since no one ever seems to get hurt, it's quite comical.

What isn't comical is 40lk/403b participants walking around with a very dangerous hole in their retirement accounts. Unlike the Stooges, what investors can't see is dangerous and can do permanent damage, and here's the thing, the 401k/403b participants I have recently met with are not Stooges by any stretch. They are lawyers, successful business owners, principals of education, and people with post graduate degrees.

What I have seen is there is no attention given, nor education into the cornerstone of all investing, DIVERSIFICATION! One gentleman has 75% of their portfolio invested into individually owned U.S. Small Company Stocks. Now this gentleman has already seen his portfolio take a 50% drop in value, he knows he is not appropriately diversified, but has no idea of what a properly diversified portfolio looks like. Worst of all, he had his portfolio put together by a "trusted" financial advisor. He hasn't been given any education or gained any understanding of diversification. What will he do if the minus 50% happens again just as he and his wife are getting ready to retire? What investments has ever generated a rebounded of 100%? Answer: None.

A lawyer who I met with and reviewed their 401k plan told me she asked the company representative to help her pick the investments for her 401k plan. They picked a Life Cycle Fund and she had no reason to doubt the sincerity or the credibility of the advice she had been given. As it turns out, 68% of her 401k plan is invested in U.S. Large Company Value Stocks. This is an asset class that has gone up by as much as 37%, but has also seen years that have been a negative 37%. This highly educated woman is walking around without any clue that the most serious money she owns is sitting in such a volatile position. When does the shoe drop? What portion of her portfolio is in a position to offset 68% of her portfolio absorbing a 37% loss? Answer: No portion is going to offset such a loss.

Lack of diversification also affects a person's ability to keep up with inflation. An early forties aged couple showed me their retirement statements. Since 2007 her husband's portfolio has lost one percent in purchasing power for every year he has owned the account. Not only has he unknowingly been paying a one percent insurance charge along with all the other investment fees, half of his money is in a fixed interest account. While since 2007 until today, U.S. Large Company Stocks have gone up 58.60% and U.S. Micro Cap Stocks have gone up 41.42% , 50% of his account has been stuck doing a measly two percent and has not benefited one bit from the stock market's run up. He can't go back and make up the returns he didn't capture and he can't go back and undue the damage the cost of living has done to the value of his retirement account.

To make matters worse, the wife's 401k plan has 62% of her retirement account in U.S. Large Company Stocks. Remember 2008? Remember U.S. Large Company Stocks going down by 37%? Do you think this won't happen again? How does a person recover from 62% of their retirement account going down by 37%? Answer: They don't. All the possibilities that were available when retiring on a certain amount of money are gone. Sure, this couple, like many others, will adjust, but what a tragedy to learn that all you had to give up was completely and easily avoidable with a better understanding of what it means to be diversified and how to achieve it.

Now as I pondered two weeks of seeing 401k/403b participants with little to no understanding of how poorly diversified they were and the jeopardy it put their retirement in, I wondered how much of the $14 trillion dollars Americans have invested in these plans is in the exact same position? How bad could it get? How will people ever get the coaching they need when apparently the participant can't see the hole in their retirement plans and the mutual fund companies are merely throwing a rug over the problem?

Plan participants and their employers have got to start paying more attention to the conversation that is being directed towards their participants. Less attention has to be given to the five star funds that populate their investment options and be more concerned as to whether or not they are being asked the right questions. Do they understand how to measure diversification in their portfolios? Do they fully understand the implications and applications of diversification in their portfolio? Getting the answers to these questions might not be as convenient as throwing a rug over the hole in the floor, but they are going to help investors see the holes and dangers they weren't able to see previously. They will be more fully engaged in creating their financial security and have the control where it belongs, in their hands, not in any one else's. Ultimately, investors will be experiencing a whole lot more peace of mind.

Brendan Magee is the founder and president of Inevitable Wealth Coaching. If you have questions or comments call 610-446-4322 or e-mail Brendan@coachgee.com.