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Avoid 401(k) mine fields
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July 22, 1999: 12:22 p.m. ET
Do your homework, stay diversified, and save as much as you can
By Staff Writer Martine Costello
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NEW YORK (CNNfn) - Financial adviser Melanie DiCenso has seen the look plenty of times. A sheepish client skulks into her office and admits he switched around his 401(k) portfolio to chase the latest hot returns.
Usually, the client says he listened to the advice of the guy sitting next to him at work. Most of the time, the client gets burned.
"Somebody at work says they got great returns in this or that," said DiCenso, a certified financial planner with Equitas America in Royal Oak, Mich. "Most people only look at returns when they make their choices. That's really scary."
Trying to figure out the best strategy for your 401(k) can be tricky. Your choices may be limited and you may not get much more than generic advice from your company. There could be complicated tax implications. Plans also vary so widely from company to company that you really need to do your homework.
If you make the wrong decisions, you could pay the price later when all of your friends are relaxing on a beach in Florida.
"People are making emotional decisions," said Charles Hamowy, a senior financial advisor for American Express Financial Advisors in New York.
Getting started
The first thing you need to do is figure out how much you'll need for retirement and decide how much risk you can live with.
"You need to do your own financial planning to find out how much you need to save," said Michael Lipsey, a certified financial planner with Creative Financial Group in Atlanta. "The problem in discussing 401(k) plans is every one is different."
DiCenso said the law requires a company to offer at least five options: Some type of money market fund; an income or a bond fund; growth funds, including conservative and aggressive choices; balanced funds, and U.S. government securities.
"A lot of companies want the bigger fund names," DiCenso said. In the Detroit area, for example, Ford (F) and General Motors (GM) use Fidelity, while Chrysler (DCX) uses Merrill Lynch. Meritor (MRA), the former Rockwell International, uses T. Rowe Price.
But many plans don't have international funds, or varied offerings in mid- and small-caps, so it's harder to do asset allocation, Hamowy said. If you have those choices you should include them in your portfolio, he said.
"Diversification is critical," Hamowy said.
Another problem is risky companies sometimes have risky 401(k) options, Hamowy said. For example, he knows of a technology company that offers only tech funds.
Many companies also will offer a fund with their own stock, which carries other possible mine fields.
For example, IBM employees who wanted to retire before the company was reorganizing in the early 1990s probably suffered when the stock dropped from about 180 to 45, Hamowy said.
"They lost their wealth," Hamowy said.
Lipsey agreed.
"I'd say no more than around 10 percent in your company's stock," Lipsey said. "The biggest mistake people make is they put too much money in their company stock. People tend to be overconfident about their own companies."
Making contributions
Hamowy thinks that anybody over age 30 should contribute the maximum to a 401(k), which is often 15 percent in plans, or the maximum amount allowed under federal law of $10,000 a year.
While the amount you'll need will vary widely, DiCenso has seen many clients between the ages of 52 and 65 who have 401(k)s valued at $300,000 to $800,000.
"If they have 30 years to work, and they put a little away at a time, they'll have $1 million," DiCenso said.
In any case, you should always contribute enough to get the maximum matching dollars from your employer. If you don't, you're throwing money away.
And keep in mind that you can't deduct contributions to an IRA if you have a 401(k) unless you're income falls below $60,000 for a couple or $40,000 for a single person. In that case, a Roth IRA is a good companion to your 401(k), Hamowy said. With a Roth IRA you can't deduct the contributions but the cash is tax-free upon withdrawal.
"A Roth IRA with a 401(k) makes a lot of sense," Hamowy said.
As far as figuring out how to allocate your portfolio, it will depend on your own investing objectives. But generally, if you have 10 years or more to invest, you should put the bulk in growth stock funds rather than bonds and bond funds, Lipsey said. A young person starting out would want 80 percent to 100 percent in the growth fund. As you get closer to retirement, you may want to scale back aggressive funds.
"That's easier to say than do," Lipsey said. "People think they are ready to assume more risk than they actually are."
Morningstar, the Chicago fund-tracker, recently announced changes in its closely-watched 401(k) plan. The company dropped PIMCO stocksPlus; Lindner Asset Allocation; Liberty-Newport Tiger; Fidelity Real Estate Investment; T. Rowe Price New Era; PBGH Growth; and T. Rowe Price New Income funds, according to analyst Tricia Rothchild.
But Morningstar added Vanguard 500 Index; Harbor Capital Appreciation; Oakmark Select; MSDW Institutional U.S. Real Estate; Vanguard LifeStrategy Growth; PIMCO High Yield; MAS Mid-Cap Growth; T. Rowe Price Small Cap; and PIMCO Total Return funds, Rothchild said.
Morningstar based its decisions on factors such as the length of a fund's track record; manager tenure; consistent performance; expenses; style consistency and risk-adjusted performance rankings, according to Rothchild.
Whatever you decide, the important thing to keep in mind is that even though there are many common mistakes, there isn't one right way or one wrong way to design a 401(k), DiCenso said.
"There are a lot of different strategies for retiring people," DiCenso said. 
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