Written By: Jason T. Willms
There has been a long held stigma against making changes to a 401(k) plan, but in order to maximize returns, observation and stewardship are imperative. 401(k)’s are designed to ignore short term volatility, but the intelligent investor can capitalize on these fluctuations to strengthen their portfolio for retirement.
- Understand Fees & Cost Structure
Managers justify fees as compensation for generating “above average” returns. However, the most successful funds are the ones with the lowest fees. Morningstar research recently released a study by Russel Kinnel that stated the following:
“our [Morningstar’s] research continues to find that fund fees are a strong and dependable predictor of future success. We found that the cheapest funds were at least two to three times more likely to succeed than the priciest funds … which clearly indicates that investors should keep cost in mind no matter what type of fund they are considering.”
This being true, an investor can maximize returns by looking for investments with the lowest asset weighted expense ratios. Current holdings with a ratio greater than 1 should be reevaluated and sold to fund the purchase of lower cost comparable investments, i.e. selling an active fund and buying an ETF. Purchases must also be scrutinized using this technique. Any investments that have ratios exceeding 1 should not be pursued. This ensures a low expense ratio for the portfolio as a whole, increasing long term returns.
401(k) investors should also be careful of “target-date” funds because they have costly fee structures. For those with the expertise, move your investment into a standard 401(k) and manage it to reduce costs.
- Avoid “Tunnel Vision”
Many investors are guilty of “tunnel vision.” This causes two problems in retirement planning. First, without critical/unbiased evaluation, investors become over confident in their current holdings and “blinded” to any new options. This can result in missing advantageous opportunities that arise in the market, hindering long term growth.
“Tunnel vision” also causes a lack of diversification which exposes investors to unnecessary risk and uncertainty. The most successful investors are those that can be critical of themselves. This self-criticism combined with careful and consistent observation will ensure an appropriately balanced and successful portfolio.
- Review and Rebalance Asset Allocation
401(k) holders should be checking their investments at least once a year to avoid the “set-it and forget-it” mentality. 401(k)’s are developed to “weather the storm”, but proper stewardship allows an investor to capitalize on market opportunities and maximize returns. This maintenance ensures appropriate weighting across investment types, proper exposure to different sectors, and protection against valuation changes.
Carolyn Bigda, of Money.com, provides possible rebalancing criteria. She states that if any of your weights are off by more than 5% from the desired mix, then it is time to make some moves.
Current market conditions have seen an inflation of stock valuations, and a momentum shift seems to be on the horizon. This exposes the investor to value loss. In order to combat this, individuals should be looking for “undervalued” or “fairly-valued” investment options by analyzing P/E ratios. Strong companies with low P/E ratios are better protected against changing economic conditions. Another source of undervalued investments is the foreign market. Foreign investments add diversification and tend to have lower P/E ratios, but experience unique risks. A mutual fund or an ETF that operates in that market would be the best option to mitigate foreign investment risks.
Recently, bonds have also been gaining more attention. The Fed just raised rates at their last meeting and this has caused bond valuations to drop slightly. With more possible hikes in the future, bond investments may be more volatile until rates level off. Bonds do still provide a steady income from coupon payments that can be used to bolster a portfolio, but investors should also be looking for other complimentary income streams.
Regardless of investment strategy or preference the most important aspect of successful investing is to be your own active manager and participate in your retirement planning.
- Think Big Picture
Thinking “big picture” requires the investor to consider four things: their 401(k), all the other investments they currently hold, their age, and their retirement time frame. Many 401(k) accounts have the ability to defer certain taxes that would be charged on a normal “taxable” account. Simple strategies such as this one could save an investor money every year and result in greater value.
In a “holistic” strategy, taking age into consideration becomes extremely important. The closer an individual gets to retirement, the more stable and secure an investment must become. This is to protect that future income stream necessary in retirement. Younger individuals who are currently working and plan to remain working can implement more aggressive investment strategies.
Current and future market expectations are also crucial to success. Retiring into a bear market can prove catastrophic for an investor completely reliant on equities because they would be selling the stocks while in a downturn. A strategy suggested by Peter Mallouk, president of Creative Planning, would be to hold short term bonds equivalent to five years’ worth of expenses. The use of bonds essentially “locks-in” that income stream regardless of stock market fluctuations and protects the investor from a decline in the economy.
- Save, Save, Save!
The importance of saving cannot be overstated. According to Stuart Ritter, of PNC Wealth Management, “How much you save has the biggest influence on your retirement readiness.” The discipline to save and contribute to your retirement account is the foundation of retirement planning because it provides the building blocks to grow through investment. The most successful retirement savers are not the ones who sporadically contribute large amounts, but the individuals that consistently submit contributions that can develop and grow over the long term.
Link to an Informative Fee Study by Morningstar HERE.
Coombes, Andrea. “It’s Time For Your 401(k)’s Annual Physical.” The Wall Street Journal. Dow Jones & Company, 06 Nov. 2016. Web. 30 Nov. 2016.
Bigda, Carolyn. “5 Smart 401(k) Moves to Make Now.” Time. Time, 26 2016. Web. 30 Nov. 2016.
Morningstar, Inc. “Study by Morningstar’s Russel Kinnel Shows Fund Fees Are Proven Predicators of Future Success.” Study by Morningstar’s Russel Kinnel Shows Fund Fees Are Proven Predicators of Future Success. PR Newswire, a Cision Company, 05 May 2016. Web. 30 Nov. 2016.