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401(k)s: Real simple
You soon may be making far fewer and far simpler decisions about how to manage your nest egg.
July 22, 2005: 11:47 AM EDT
By Jeanne Sahadi, CNN/Money senior writer

NEW YORK (CNN/Money) - Research has shown that those of us eligible to participate in our companies' 401(k) plans are not a very proactive bunch.

We're slow to join the plan, feel overwhelmed if faced with too many investment choices, and rarely, if ever, rebalance our portfolios. Plus, few of us even contribute the maximum allowed, or regularly increase our contributions.

So employers are moving toward a streamlined 401(k) that will have a number of default options designed to improve workers' chances of building a solid nest egg. The changes include:

Automatic enrollment: Once a worker is eligible, unless he tells his company otherwise, he will automatically be enrolled in the plan. A typical default contribution rate is 3 percent of pay, and the default investment is typically a money market or stable value fund, or a balanced or asset allocation fund.

Automatic rebalancing: You often hear that a given allocation of stocks and bonds historically has achieved a certain annual average return. For example, based on historical returns, a 60-40 portfolio has a high probability of averaging 7.5 percent annual returns over a period of 10 years or more, said Wayne Bogosian, president of the Personal Financial Education Group.

But that assumes the portfolio stays allocated that way all the time. So if stocks do very poorly one year and bonds do very well, it's possible the allocation will shift to 50-50.

An automatic rebalancing option lets you choose to have your portfolio mix adjusted once a year to restore your target allocation of 60-40.

Automatic contribution increases: Some companies will automatically increase your contributions or let you opt to do so -- once a year, typically at raise time. The most common increase is 1 percent to 2 percent of your gross.

You're not likely to notice much of a difference in your take-home pay.

Say you get a 4 percent raise and 1 percent of it automatically goes to your 401(k). "After taxes, it's probably not even a rounding error," Bogosian said.

Fewer investment choices: The goal is quality rather than quantity, plus ease of use.

"Employers are trying to give workers vehicles such as lifestyle funds that make diversification easier," said Lori Lucas, director of participant research at Hewitt Associates in a survey of 450 large companies retirement plans.

For instance, Time Warner CNN/Money's parent used to offer hundreds of funds in its 401(k). Starting this fall, it will offer just 17:

Four asset allocation funds, each of which reflects a different risk tolerance (e.g., a moderate fund, a growth fund, etc.)

Eight actively managed fund-of-funds that invest in a given asset class (e.g., diversified bond fund, large-cap equity fund, etc.).

Four index funds (S&P 500, international equity, small-cap equity and bond)

One company stock fund

For plan participants who wish to invest in other funds, they may do so through a self-directed brokerage window.

How to handle the changes

Bogosian advocates a set-it-and-forget-it strategy.

Figure out roughly how much you need to save per year to meet your retirement goal and the average return you'll need to achieve that goal. "Your responsibility is to understand what your target rate of return is," he said. (For help figuring out yours, try our savings calculator.)

And by that he means your "personal rate of return," which companies like Fidelity calculate for you based on the performance of your 401(k) portfolio as a whole.

Then pick a portfolio that offers the best shot at achieving that return and which suits your time horizon and tolerance for risk.

You might pick a target-maturity fund appropriate to your age. It grows more conservative as you near retirement.

Or you might implement your target allocation using a combination of index funds and actively managed funds in your plan. But if you do, sign up for automatic rebalancing.

And while you're at it, sign up for automatic contribution increases if you're not already maxing out your contributions.

Bottom line, Bogosian said, "putting things on autopilot really simplifies your life."  Top of page

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