Updated: May 3, 2013 12:14PM
Originally published: July 12, 2001
Some investing basics in light of 401(k) news
For the first time in the 20-year history of 40l(k) retirement savings plans, the average account lost money last year--even after thousands of dollars in new contributions.
But why are people surprised?
Is it possible that a whole generation of investors really didn’t understand that stocks go down as well as up?
The interest in this latest statistic--that the average 40l(k) retirement-plan account shrank to $41,919 in 2000 from $46,740 in 1999, according to Cerulli Associates--reminds me that it’s time to refocus on some investment basics. And it’s also time to focus on some new tools available to investors so they can manage their accounts like the most successful professionals.
BASIC NO. 1: The long-term historical average return of a diversified portfolio of large-company stocks is 11 percent per year. But, like all averages, that average return is made up of some above average years and some below average years. If you look back on the last eight years, it’s easy to see that we’ve been blessed with consecutive years of above-average returns. It’s now entirely probable that we will see some years of below-average returns.
BASIC NO. 2: Long term means just that--long term. At least 20 years. It makes very little sense to draw conclusions from two or three years of stock market performance. That kind of thinking, based on the late 1990s, could lead to the mistaken belief that the stock market always goes up. If you’re investing for the long term, then short-term fluctuations in account value shouldn’t affect your current financial lifestyle or your emotional well-being.
BASIC NO. 3: Diversified means just that--a variety of stocks and a variety of mutual funds. Many corporations match employee deposits in their 401(k) plans with company stock, and that leads to an overwhelming investment concentration in just one company. Not only are you dependent on your company for your job, but for your retirement benefits, as well. And that increases your overall risk level.
BASIC NO. 4: Accepting some risk in your investments is entirely appropriate. How much risk you should take depends on your situation.
According to Ibbotson Associates, if you put $1 into Treasury bills 75 years ago, in 1925, today it would be worth about just under $11. That’s an average annual return of 3.1 percent. If you had invested that same $1 in 1925 in a diversified portfolio of large-company stocks, your account would be worth nearly $2,600 today, an average annual return of 11 percent.
Diversification, long-term commitments and regular monthly investments work to diminish risk. But if you try to avoid risk completely, you’ll be far less likely to reach your financial goals.
Because of the recent declines in stock market returns, many ‘’experts’’ are questioning whether individuals have the ability, tools and emotional stability to manage their own retirement money. But professionals have only one advantage over individuals today: It’s not their money. So they can be less emotional when it comes to making buy and sell decisions.
But when it comes to having the tools to tackle the job of investment management, individuals can now act on an equal footing with the pros. That’s because a growing number of companies offer 40l(k) participants access to financial modeling services such as Financial Engines, mPower, or the new Fidelity Portfolio Planner.
The Financial Engines service (www.financialengines.com) was created by William Sharpe, who won the Nobel prize for ‘’modern portfolio theory’’--the basic technique used by professionals to optimize investment performance. The mPower service will soon be available to individuals in partnership with MSN MoneyCentral (www.MoneyCentral.com). And Fidelity has just made its Portfolio Planner available free online to anyone with any Fidelity account (www.Fidelity.com).
These online computer tools allow individuals to establish goals and track their progress. They give sophisticated advice about asset allocation, using Monte Carlo variable modeling to predict the likelihood of investment success in meeting your personal goals.
Now, there’s no excuse for being ignorant--about either the investment basics or having the sophisticated tools to make smart long-term investment and savings decisions. All you have left to conquer is your own emotions, the most difficult task in all investing. And that’s the Savage Truth.
Terry Savage is a registered investment adviser for stocks and commodities and is on the board of directors of McDonald’s Corp. and Pennzoil-Quaker State Co. Send questions via e-mail at email@example.com.