Reason #1. ‘Have your cake and eat it too’.

What could be better? For as long as you work you can continue your tax-advantaged contributions to the firm’s 401(k). Meanwhile, your 401(k) balance could be rolled into an IRA and invested to help meet your own personal preferences and financial goals. The IRA’s investments would be chosen and structured with you in mind since an IRA has more investment choices. The 401 (k) investment choices were not made with only you in mind.

 

Beneficiary rules for 401(k)s are not simple. Where there is a non-spouse beneficiary of a 401(k) plan, a child for example, careful steps have to be taken for the transfer of a 401(k) to an IRA even after changes in the law in 2006. Failure to follow these cumbersome steps or the existing plan provisions themselves may not allow a 401(k) rollover and could mean a massive acceleration of the payment of income taxes. If you have a non-spouse beneficiary of your 401(k) or there exists a chance you and your spouse could perish together leaving children as beneficiaries, your 401(k) balance could be at the mercy of the 401(k) plan rules.

 

Rarely do 401(k) plans offer the full array of investments that investors use to help build wealth and mitigate risk. Many 401(k) plans offer mutual funds for investors including:

Emerging market funds, sector funds, such as those that concentrate in natural resources or precious metals, and commodity funds, are a few examples of investments that can be held in an IRA. Individually, some of these funds may have more risk and volatility. Yet, when used judiciously within a broader portfolio, they may lower overall risk and portfolio volatility. Funds that can invest short or long in stocks are rarely found in a 401(k) plan because of the prudent man rule. Your 401(k) plan is not reflective of what the investment universe has to offer and the risks you wish to assume. Why ‘play with half the deck’. It’s far too important for that. You owe it to yourself to seek a higher level of service and a broader array of investment options available outside your 401(k).

 

Reason #4. A 401(k) is not designed to be investor-specific. On the contrary, it is purposely designed for EVERYONE and ANYONE.

Could you benefit by the returns of highly rated foreign bonds? Could you benefit by owning a fund that invests only in natural resources stocks? Could adding Industrial REITS lower your portfolio’s volatility? Would owning individual bonds be cheaper than owning bond funds? The point here is that your 401(k) is simply a limited ‘bucket’ of investments, designed with no one in mind. No one thought about your personal goals, your individual needs or your family legacy when they set the investment lineup. Plain vanilla was the flavor of choice. It was easier that way, but is it best for you?

 

Let’s say your belief is that the domestic stock market is going to decline for a period of time. What do you do in your 401(k) to address that belief? I see four choices. You might say to yourself, I am willing to ride out another downturn or, I am putting my money in the money market fund and hope that provides stability, or I will invest in bonds or foreign stocks only and hope they don’t perform like the domestic stock market. Or, you might decide on some combination of the three. You could use funds that incorporate ‘short’ strategies, if your 401(k) offers them. Probably not. You could look at investments that provide an income for as long as you live, regardless of stock or bond market performance, if it were available. Probably not. You could own investments that move totally independently of any stock or bond market worldwide if they were in your plan. Probably not. To summarize, it is easier to protect your 401(k) balance when it is not in a 401(k).

 

When that happens your diversification suffers. We have a great deal of respect for some families of mutual funds. They are well-managed, performance is solid and fees are modest. What we have noticed in looking carefully at the funds within the fund family are that in some cases many of the stocks held by the funds are present in most their domestic stock funds. That shouldn’t surprise anyone. The fund managers communicate. That overlap can adversely affect the benefits of diversification. An investor might think they are getting greater diversity between funds than is actually the case. What this means is that the funds which have this overlap will react to market forces similarly. What influences one fund will influence the other. Diversification is a great way to manage risk. Why not obtain broader diversity and manage risk most effectively outside the 401(k) where fund family diversification is more easily accomplished?

 

‘A Boston Business Journal sampling of 241 Fidelity mutual funds shows that roughly 30 percent of those offerings -- some 70 funds -- have had new portfolio managers appointed in the last 18 months.’ (Boston Business Journal, June 17, 2007). This occurrence is not specific to one fund family. Mutual fund managers are changed for many reasons including good performance, getting them a better deal elsewhere, poor performance, retirement and personal problems to name a few. The only thing constant is change! In actively managed funds, the manager is the person making the purchase and sale decisions. Your 401(k) performance is dependent on his/her abilities more than anything else. You are not going to get an e-mail telling you of manager changes for the funds in your 401(k). You can find it in the yearly prospectuses sent to you by the firms if you read them. You can also find it on the web, if you are looking regularly. You could also get a diligent advisor who will watch your investments and monitor manager changes and offer valuable insight, while you do the things you enjoy doing.

 

Institutional money managers don’t handle 401(k)’s and don’t want to. Too many transactions, constant inflows and outflows and liquidations and transfers demand too much attention and costly and time-consuming administration. Many of the best institutional money managers would like to simply manage money and seek out endowments, charitable foundations, pension plans and high net worth investors. Minimums of $10 million and up are not uncommon. These firms may attract the best and the brightest money managers and their publicly available results may attest to it. Wouldn’t it be nice if a small investor had access to this type of money manager? YOU DO! But, not in your 401(k). Many investment firms offer access to these institutional money managers through asset management programs offered to ‘smaller investors’.

 

I have seen very few 401(k)’s that offer the chance to buy individual bonds with the money in your account. One or two bond fund choices is the norm.

Individual laddered bonds offer some distinct advantages:

Laddered bonds will most likely be part of your retirement portfolio, if they are not now. Bonds have fixed principal value and yield if held to maturity. Bonds have inflation, credit and interest rate risk. Prices of fixed-income securities may fluctuate due to interest rate changes. An investor  may lose monety if bonds are sold before maturity.  Why not get the advantages and control of owning your own laddered bonds now.

 

If you could guarantee that your 401(k) would continue to pay you an increasing income for as long as you and your spouse lived, would you feel better about entering the 30+ years retirement may have in store for you?

This is not your father’s retirement. Most of you were sons and daughters of those who saw the roaring 20’s turn into the depression. You grew up with stories of no income and bread lines and suffering because of lack of money. Life expectancy in 1945 was 65.9 years and a first class stamp was $.03 and the Dow reached a high of 195! People lived for ‘today’. Few lived long enough after working to prompt anyone to take a long range view. And had they, would any have predicted the changes that have taken place? Today, one of a 65-year old couple will reach age 90, first class stamps have increased more than 13-fold since 1945 and the Dow sits at around 12,500.

Where there is so much uncertainty about the future, it is possible to obtain investment products from financially strong companies that do exactly what I stated…guarantee you an income for as long as you live. (Guarantees are based on the claims paying ability of the issuer. You have the choice when to start that income and you know how much it will be, forever. They are not available in 401(k)’s. Perhaps your situation could benefit from dependable income.