Post by Zoinkers on Sept 19, 2006 17:19:20 GMT -5
Investor's Business Daily
Invest Your 401(k) Like A Pension Pro
Monday September 18, 7:00 pm ET
Paul Katzeff
Want to invest as successfully as the pros do?
You can boost your odds of doing so by avoiding a basic error made by many amateur investors. That misstep accounts for much of the outperformance by traditional pension plans vs. 401(k) plans. Dodge that common miscue and your returns can climb.
Pension plans outgained 401(k)s by an annual average of one percentage point from 1988 through 2004, according to a new study by the Boston College Center for Retirement Research.
Over 40 years such a gap would turn into a 20% bigger nest egg for pension plans. So if an employer's pension plan accumulates $600,000 on each worker's behalf, each employee typically builds only $480,000 in a 401(k) account.
Pensions averaged a 10.7% a year return, on an asset weighted basis. Asset weighting measures return by each dollar invested. Larger plans with more members and more assets counted for more in the study than smaller plans. Defined contribution plans averaged 9.7%.
That result is due in part to fees, which cut 401(k) returns, the study says. It's also because pension plans can hire skilled money managers. And perhaps the most glaring mistake individual investors make is to not invest aggressively enough.
One-third, or 33.3%, of 401(k) plan members invested nothing in stocks or stock funds during the 16-year study period. The period starts near the bottom of the 1987 bear market and ends well off the peak reached before the 2000-02 bear market.
Omitting stocks wastes time and opportunity, says T. Rowe Price financial planner Stuart Ritter.
From 1926 through 2005, stocks averaged a 10.4% annual return, the study says, citing Ibbotson Associates data. Corporate bonds averaged 5.9%. U.S. Treasury bills averaged 3.7%, barely staying ahead of inflation's 3% average.
Longer Lifespans
"People should definitely have money in stocks," Ritter said. "One of the reasons they don't is because they're framing their thinking in the wrong time horizons."
Plan members are concerned about losing money, Ritter says. And they envision losing money in the short term.
"People worry too much about what might happen in the next three months," Ritter said. "Their time horizon should be 30, 40 or 50 years. The potential growth of diversified equities over that longer period far outweighs what might happen during just three months."
Short-term volatility is not totally irrelevant. It just should not overly impact long-term strategy, he says.
"Our asset-allocation models say that if your time period is two years or less, then you should have all of your money in money market funds," Ritter added. "But life expectancy even for an 80-year-old is more than two years. So he still needs to worry about investing at least partially for growth."
Many IBD readers put the time and effort into investing in growth stocks over their lifetimes. Even well after retirement, they can generate income for living expenses by selling off shares. But many investors instead prefer to shift some assets to income-generating bonds or bond funds.
T. Rowe Price has a formula for deciding how much of a portfolio to keep in stock or stock funds.
"The old conventional wisdom used to be that 100 minus your age was the percentage you should have in stock," Ritter said. When your grandfather reached age 80, that meant he should have only 20% of his portfolio in stock.
"Now we say 110 minus your age, then multiply that number by 1.25," Ritter said. Today at age 80, you'd subtract 80 from 110, then multiply the result, 30, by 1.25. That tells you to keep 37.5% of your money in stock.
T. Rowe Price's formula assumes you'll live to age 95. If you're in good health and your parents, grandparents and so on typically lived even longer, you can tweak the formula.
Life-Cycle Funds
You can do that using life-cycle mutual funds. Say you are 55 years old. Suppose you expect to reach the century mark. That gives you 45 years. At T. Rowe Price's Web site, look for the retirement fund whose target date is closest to 2049. That fund's stock allocation is 93.5%.
"When your grandparents retired, they put everything they had into bonds and lived off the income," Ritter said. "That worked because they expected to live only 10 more years. But that won't work for you. You can expect to live for another 30 years. Your strategy has to change."
Invest Your 401(k) Like A Pension Pro
Monday September 18, 7:00 pm ET
Paul Katzeff
Want to invest as successfully as the pros do?
You can boost your odds of doing so by avoiding a basic error made by many amateur investors. That misstep accounts for much of the outperformance by traditional pension plans vs. 401(k) plans. Dodge that common miscue and your returns can climb.
Pension plans outgained 401(k)s by an annual average of one percentage point from 1988 through 2004, according to a new study by the Boston College Center for Retirement Research.
Over 40 years such a gap would turn into a 20% bigger nest egg for pension plans. So if an employer's pension plan accumulates $600,000 on each worker's behalf, each employee typically builds only $480,000 in a 401(k) account.
Pensions averaged a 10.7% a year return, on an asset weighted basis. Asset weighting measures return by each dollar invested. Larger plans with more members and more assets counted for more in the study than smaller plans. Defined contribution plans averaged 9.7%.
That result is due in part to fees, which cut 401(k) returns, the study says. It's also because pension plans can hire skilled money managers. And perhaps the most glaring mistake individual investors make is to not invest aggressively enough.
One-third, or 33.3%, of 401(k) plan members invested nothing in stocks or stock funds during the 16-year study period. The period starts near the bottom of the 1987 bear market and ends well off the peak reached before the 2000-02 bear market.
Omitting stocks wastes time and opportunity, says T. Rowe Price financial planner Stuart Ritter.
From 1926 through 2005, stocks averaged a 10.4% annual return, the study says, citing Ibbotson Associates data. Corporate bonds averaged 5.9%. U.S. Treasury bills averaged 3.7%, barely staying ahead of inflation's 3% average.
Longer Lifespans
"People should definitely have money in stocks," Ritter said. "One of the reasons they don't is because they're framing their thinking in the wrong time horizons."
Plan members are concerned about losing money, Ritter says. And they envision losing money in the short term.
"People worry too much about what might happen in the next three months," Ritter said. "Their time horizon should be 30, 40 or 50 years. The potential growth of diversified equities over that longer period far outweighs what might happen during just three months."
Short-term volatility is not totally irrelevant. It just should not overly impact long-term strategy, he says.
"Our asset-allocation models say that if your time period is two years or less, then you should have all of your money in money market funds," Ritter added. "But life expectancy even for an 80-year-old is more than two years. So he still needs to worry about investing at least partially for growth."
Many IBD readers put the time and effort into investing in growth stocks over their lifetimes. Even well after retirement, they can generate income for living expenses by selling off shares. But many investors instead prefer to shift some assets to income-generating bonds or bond funds.
T. Rowe Price has a formula for deciding how much of a portfolio to keep in stock or stock funds.
"The old conventional wisdom used to be that 100 minus your age was the percentage you should have in stock," Ritter said. When your grandfather reached age 80, that meant he should have only 20% of his portfolio in stock.
"Now we say 110 minus your age, then multiply that number by 1.25," Ritter said. Today at age 80, you'd subtract 80 from 110, then multiply the result, 30, by 1.25. That tells you to keep 37.5% of your money in stock.
T. Rowe Price's formula assumes you'll live to age 95. If you're in good health and your parents, grandparents and so on typically lived even longer, you can tweak the formula.
Life-Cycle Funds
You can do that using life-cycle mutual funds. Say you are 55 years old. Suppose you expect to reach the century mark. That gives you 45 years. At T. Rowe Price's Web site, look for the retirement fund whose target date is closest to 2049. That fund's stock allocation is 93.5%.
"When your grandparents retired, they put everything they had into bonds and lived off the income," Ritter said. "That worked because they expected to live only 10 more years. But that won't work for you. You can expect to live for another 30 years. Your strategy has to change."