If you are afraid of the stock market you might not like where your money is headed in the company 401(k) plan.
But don't fight it. A good dose of stocks, blended together with some bonds in mutual funds, will be good for you--especially if you are years away from retirement and won't panic in a downturn.
And the federal government, and your employer, are working to make sure you take your medicine.
Last week, the Labor Department set in motion rules that are likely to revolutionize the way millions of Americans save for retirement. Instead of leaving people on their own to potentially blunder through the investment process with 401(k) plans, the government has laid out a preferred route. It calls for people to invest in a mixture of stocks and bonds designed to grow their money effectively based on the years remaining until they retire.
The idea is to discourage people from the mistakes that cripple their savings and cause them to reach retirement without adequate funds. Too often people--especially young investors--think they are keeping their money safe by avoiding the stock market. About 20 percent are drawn to the safest options in their 401(k) plans--stable value or money market funds--according to Pam Hess, a 401(k) analyst with Hewitt Associates.
Although investors generally don't lose money in these funds, they don't make much money either. The average stable value fund has earned 4.65 percent a year over the last five years, according to Hueler Analytics. Meanwhile, the average fund that blended a moderate mixture of stocks and bonds climbed 11.6 percent a year, according to Lipper Inc.
The difference may not seem pronounced. But over a lifetime of investing, it is. If a 35-year-old invested $5,000 a year in a 401(k) and earned 5 percent on average a year, he or she would have about $349,000 by retirement. If the person earned 7 percent on average in a conservative mixture of stock and bond funds, it would be about $505,000.
With $500,000 in savings a person could withdraw about $20,000 the first year of retirement, following a common financial planning rule of thumb of 4 to 5 percent withdrawals so you don't deplete your savings too soon. Then that amount would increase each year for inflation.
The federal government has decided not to leave the investing habits of Americans up to chance because large shortfalls are projected as the roughly 78 million Baby Boomers go through retirement. According to the Employee Benefit Research Institute, Americans will run $45 billion short of basic living expenses annually by the year 2030.
According to the Congressional Research Service, half of Americans within 10 years of retirement have saved no more than $88,000.
Congress tried to improve the odds that people would have enough retirement savings by passing a pension law last year that gave employers the go-ahead to become involved. The government told employers that they no longer had to wait for employees to take the initiative and sign up for the company retirement savings plan. Instead, the employers could enroll employees automatically and reroute a portion of their pay--often 2 to 3 percent--into the 401(k), 403(b) or other retirement plan.
About 36 percent of large employers are using this "automatic enrollment," according to Hewitt. And a survey of employers recently shows that half of those not currently using the system are likely to add it this year. Just two years ago only 19 percent of employers were enrolling employees automatically in their 401(k) plans.
The trend is rolling so quickly that David Wray, president of the Profit Sharing/401(k) Council of America, estimates that virtually all major employers will be enrolling their workers in 401(k) plans and investing the money in a mixture of stocks and bonds within five years.
Some employers have hesitated until recently because they wanted more clarity from the government about investing employee money. Those that did invest money often chose the safety of stable value funds because they did not want to risk losing employee money in a downturn and end up being sued.
But the Labor Department cleared the way last week to a new approach.
In essence it said that employers won't be liable in a suit if they are investing in a diversified mixture of stocks and bonds.
Employers can put employees in one of three options: Balanced funds, which generally keep about 60 percent of a person's money in stocks and 40 percent in bonds; target-date funds, which alter the mixture of stocks and bonds based on a person's age, and so-called managed accounts. In these, a professional divides up a person's money based on their age.
Under federal rules, employees may choose to opt out of the 401(k) or do their investing themselves.
But Hewitt's Hess said target-date funds are already popular with employers and employees. Administrators simply need to look at an employee's age, and can then select a single mutual fund for each person. For a person in their 20s or 30s, the mixture will be heavily weighted in stocks--perhaps 80 percent of the portfolio--to help grow savings adequately. As the person ages, more money is shifted out of the stock market and moved into bonds to reduce risks.
So at 65 a person might have a portfolio divided about 50/50 in stocks and bonds.
When target-date funds are offered, about 45 percent of employees use them, Hess said.
In research by Hewitt, about two-thirds of people with 401(k) plans say they do not feel confident about investing well, Hess noted. The new rules will take some of that pressure off.
Still, Hess and others said that individuals will not be able to simply go into their future with blinders on. Most employers invest about 3 percent of a person's pay in a 401(k) plan. And financial planners suggest 10 percent a year throughout a person's working life is necessary.
Some employers are getting workers on the right track by increasing their 401(k) contributions a little each year. But where employers are not doing this, Hess said workers need to increase their savings regularly.
Gail MarksJarvis is a Your Money columnist and the author of "Saving for Retirement Without Living Like a Pauper or Winning the Lottery." Contact her at email@example.com.