401k Investment Advice

401k Investment Advice: Kiss Old-Style Pensions GoodbyePlus, 3 Ways To Maximize Your 401k Returns

by Mark Skousen, Chairman, Investment U
Monday, March 13, 2006: Issue #518

Two items in last week’s Wall Street Journal “What’s News” section caught my attention:

General Motors announced that it is replacing its traditional “defined benefit” pension plan with a “defined contribution” plan [a 401(k) plan].
Just 20% of men still work at age 65 or older, a federal report said, compared with half in 1950. For women, that number was flat at 10%.

Both these news items are important follow-ups to Investment U # 517, “How much do I need to retire?” In today’s issue, we’ll share our 401k investment advice for 2006but not before first looking at the trends in today’s pension and defined contribution plans.

The reason 20% of men don’t work past age 65 is because of their company’s overly generous pension plans. Between Social Security and their corporate pension plan, many retirees are earning an annual income equal to what they were paid when they were working.

Why the Age of Corporate Welfarism Is Over

More and more traditional companies are abandoning the traditional corporate pension plan in favor of new, more flexible, more portable 401k plans. General Motors is one of many to do this. Other old-style companies to switch include IBM and Sears. Virtually all the “new economy” companies, such as Microsoft, AOL, Home Depot, and Wal-Mart, offer 401(k) plans only.

Take a look at the chart below from the Economic Policy Institute (www.epinet.org)

And the trend has continued strongly. In 2005, according to the U.S. Department of Labor, 21% of workers participated in a defined benefit pension, while 42% participated in a defined contribution plan - twice as many.

Why the shift? Here’s the story

Why Corporate Pensions Shifted to 401k Plans: All Too Much Like Social Security

After World War II, major U.S. corporations added generous pension plans to their employee-benefit programs. These “defined benefit” plans largely imitated the federal government’s Social Security plan. Companies matched employee contributions; the money was pooled into a large investment trust fund managed by company officials; and a monthly retirement income was projected for all employees when they retired at 65.

Management guru Peter Drucker was one of the first visionaries to recognize the impact of this “unseen revolution,” which he called “pension fund socialism” because this Social Security look-alike was capturing a growing share of investment capital in the United States.

Unfortunately, Drucker and the company actuaries failed to see two trends that created huge unfunded liabilities for these old-style companies:

Retirees are living longer. In 1950, the average lifespan was 69; today it is 75.
Company pension managers invested too conservatively in government bonds and blue chip “old company” stocks that underperformed the S&P 500 Index over the years.

You might notice that these two weaknesses in corporate “defined benefit” plans are the very same weaknesses of the Social Security program.

But unlike the government, which is not very good at solving problems, corporate America has adopted a reform measure to eliminate the unfunded liability problem. How?

The Benefits of 401k Plans

The new corporate solution, the 401k plan, is a spin-off of another legislative invention - the Individual Retirement Account (IRA). The 401(k) rapidly became the business pension of choice, and there is no turning back. These “defined contribution” plans solve most of the headaches facing traditional corporate plans.

Under 401k plans, there is no longer a guaranteed projected benefit when you retire. It all depends on how much you have in your account, and how well you have invested it. Thus, there is every incentive for employees to become more knowledgeable about Wall Street, and prepare for their own retirement.
Under 401(k) plans, employees, not company officials, control their own investments by choosing among a variety of no-load mutual funds, in addition to their own company stock (optional).
The third advantage is that the plans have complete mobility; employees can move their 401(k) savings to a new employer or roll it over into an IRA.

According to recent U.S. Labor Department statistics, almost all of the major Fortune 500 companies have switched to defined-contribution plans or hybrid “cash-balance” plans.

Our 401k Investment Advice for 2006: Recommendations To Maximize Your 401k or IRA Plans:

1. Since you are now on your own in creating your own pension plan - and you will need at least $1,000,000 in your 401(k) or IRA to retire comfortably, in addition to Social Security, as I advised in Investment U # 517 - you should encourage your company to give you the broadest choice of no-load mutual funds. I am still astonished at how old-fashioned most company 401(k) plans are. Most do not give you the choice of investing in foreign stocks, precious metals, or oil and gas stocks. Tell your company you want these choices to maximize your retirement profits.

2. Take full advantage of company matching plans. Most have them, in which they will match dollar-for-dollar your contribution up to a certain percentage of your salary, usually 3% to 10%.

3. Diversify your position. Maintain a position in domestic stocks, foreign stocks, bonds, money market funds, and natural resources. Most 401(k) plans discourage frequent trading. The best advice is to invest according to your vision of long-term trends.

Good investing,

Mark

Today’s Investment U Crib Sheet

Save yourself a trip to the bookstore and take a quick look back at Investment U # 517, How Much Do I Need To Retire? Find out just how much it will take for you to retire.