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Personal Finance > Investing
Don't sell your 401(k) short
March 10, 1999: 10:04 a.m. ET

Dump those guaranteed investment contracts and go for stocks, experts say
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NEW YORK (CNNfn) - Saving for your retirement these days is no easy task.
     With the growing popularity of the 401(k) plan, it's now necessary to educate yourself on the risks and rewards of investment products that once were the domain of experts.
     From inflation to treasurys to no-load mutual funds, it's enough to make your head spin.
     But not every investment is a smart one, even those that might appear to make initial sense. Some financial advisors say guaranteed investment contracts are about as helpful to your long-term financial goals as keeping your money under a mattress.
     "What happened is a lot of people were in pension plans and many companies have switched to 401(k) plans" said Howard Isenstein, editor of Max's Investment World, an online financial publication. "Now it's up to the employees and they really don't know what to invest their money in. Unfortunately, a lot them are choosing guaranteed investment contracts."
    
The GIC

     Guaranteed investment contracts, or GICs, are a type of stable value fund. By definition, they are a contract between an insurance company and a corporate profit-sharing or pension plan that guarantees a specified rate of return on the invested capital over the life of the contract.
     They are considered highly conservative and virtually risk free, since you are "guaranteed" to get the principal back.
     But John W. Eckel, a certified financial planner with Pinnacle Investment Management Inc., said GICs are only as good as the insurance company that sells them.
     "One of the dangers of GICs is that they are only guaranteed if the insurance company has the underlying security to stand behind it," he said, noting that highly rated insurance firms are generally safe. "There have been some major problems with companies being unable to meet their obligations."
     Even those that do meet their obligations produce razor-thin returns.
     "The problem is people are still getting used to the concept of taking responsibility for themselves and they are scared," Isenstein said. "In GICs, they are guaranteed to get that money back, but it won't get them that condo in Boca (Raton, Fla.)."
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Your options

     If you've got at least 10 years before your retirement, most financial planners say you're better off putting most of your money into stocks or stock mutual funds.
     While there is certainly risk inherent in equities, Isenstein said stocks have returned an average of 11 percent a year since 1926. The current 2-year GIC is returning about 6 percent in interest accrued - and that's if you're a multi-million dollar investor.
     Returns for the average investor, under which most 401(k) participants fall, are smaller still.
     Add that to the risk of inflation (which lowers the value of your GIC as it climbs), taxes and the often higher commission and sales charges associated GICs, and you're looking at a pretty unimpressive rate of return.
     "GICs are fine investments for what they are, but they are being used wrongly by a lot of people," Isenstein said. "People with 401(k)s are buying them and they really should be buying long-term investments with higher rates of return."
    
Safety doesn't pay

     If you are particularly risk-averse, you might consider replacing that GIC with a U.S. Treasury, or a short-term corporate bond fund, such as the one offered by Vanguard. Both offer similar -- and sometimes higher -- returns, are more liquid than a GIC and are relatively risk-free.
     But even those should be kept to an absolute minimum, experts say.
    
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     Ric Edelman, author of "The Truth About Money," said regardless of your financial goals and risk tolerance, you should be putting all of your retirement money into stocks.
     "The rates of returns on GICs and short-term corporate bonds are so low they barely keep pace with taxes and inflation," he said, adding they often times don't.
     Consider this: your GIC earns you about 5 percent a year (it's higher than that currently but 5 percent is a good average). A third of that gain is lost in taxes, leaving you a return slightly above 3 percent. Inflation (though lower now) has averaged 5.5 percent for the last 25 years.
     "Most people focus on what they earn, not on what they keep," Edelman said. "It's a crime because virtually none of that money belongs in GICs."
     The only time an investment in GICs is appropriate, he said, is if you plan to retire in the next two to three years. Everyone else is wasting their time - and money.
     "I believe the primary reason people still invest in GICs is because of worker attitudes about risk," he said. "They are afraid to invest in stocks because they don't understand it. And they are afraid to lose their money. They're told that their investments can go down in value if they invest in other places."
     Focusing on safety, however, get you nowhere fast on a long-term investment.
     "Left to their own devices, (investors) naturally choose safety and it's one of the worst decisions they can make," Edelman said.
     Instead, he said, you should set up an investment plan based on "dollar cost averages." By contributing $50 a month towards the purchase of individual stocks, you automatically spread your risk over a number of years. A natural way of diversifying your risk.
    
The stats

     A recent study by the Employee Benefit Research Institute and the Investment Company Institute shows that 15 percent of 401(k) money is invested in guaranteed investment contracts. Isenstein and Edelman said that's about 14 percent too much, since only about 1 percent of investors actually belong in them.
     According to the study, about 44 percent of 401(k) assets are allocated to equity funds, 19 percent is dropped in employer stock and the remainder is invested in balanced funds, bond funds and other stable value funds.
     "The overwhelming majority of workers should have 100 percent of their assets in stock," Edelman said. "It's not risky at all. It's far riskier not to do this."Back to top
     --by staff writer Shelly K. Schwartz

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Most stock quote data provided by BATS. Market indices are shown in real time, except for the DJIA, which is delayed by two minutes. All times are ET. Disclaimer. Morningstar: © 2018 Morningstar, Inc. All Rights Reserved. Factset: FactSet Research Systems Inc. 2018. All rights reserved. Chicago Mercantile Association: Certain market data is the property of Chicago Mercantile Exchange Inc. and its licensors. All rights reserved. Dow Jones: The Dow Jones branded indices are proprietary to and are calculated, distributed and marketed by DJI Opco, a subsidiary of S&P Dow Jones Indices LLC and have been licensed for use to S&P Opco, LLC and CNN. Standard & Poor's and S&P are registered trademarks of Standard & Poor's Financial Services LLC and Dow Jones is a registered trademark of Dow Jones Trademark Holdings LLC. All content of the Dow Jones branded indices © S&P Dow Jones Indices LLC 2018 and/or its affiliates.