The 401(k) is the best tool you have to save for retirement, but it can be an awfully clumsy one.
In a typical plan, your employer essentially hands you a list of funds and says, "Here, you pick." Maybe you spend a weekend agonizing over whether to invest in this stock fund that looks for "opportunities for value," or this other one that goes after "emerging opportunities." (Both sound great!)
For some, fine-tuning a retirement portfolio becomes a fascinating pursuit; for most, it falls somewhere between tedious housekeeping and an anxiety-provoking puzzle.
The catastrophic market crash of 2008, which took the average 401(k) balance down by 30%, has done lasting damage to the confidence of savers. Even though the S&P 500 had doubled from its low, only 14% of workers at the start of 2012 were very confident about their retirement prospects, compared with 27% in 2007.
So if you've thought about just throwing up your hands, you aren't alone. "People have been given a license for a machine they don't know how to drive," says David Booth, founder and co-CEO of Dimensional Fund Advisors, chatting at his firm's headquarters in Austin.
With $235 billion under management, Dimensional has quietly built a reputation as one of the most sophisticated fund managers in the business. Its low-cost index-like funds have acquired a mystique, in part because they are mainly sold to institutions and clients of fee-only advisers.
Now Booth wants to go after a much broader market of 401(k) savers. And he has a proposition that may surprise you: You should be able to all but ignore your portfolio.
The decisions you must get right are all about planning -- how much to save, how much income you'll need -- not investing.
Dimensional's Managed DC service, which was launched in the U.S. this summer, is an intriguing entry in a small but growing category of managed 401(k) plans. Competitors include the more established Financial Engines and a firm called Guided Choice, recently tapped by Schwab to offer advice built around the brokerage giant's index funds.
What all the services have in common is that they set up and run a portfolio for each participant in a 401(k) plan, based on his or her age, savings, and income goals. (You can use one of these programs only if your employer makes it an option.)
So when you log on to your plan's website, you won't be given a menu of funds you can move money in and out of. That part is out of your hands. Instead, you'll get online tools that help you see whether your contributions are likely to get you to the retirement you want, and warn you to increase your savings when you are at risk of falling short.
It remains to be seen whether over the long run a custom approach will improve 401(k) savers' outcomes. Still, the plans are worth your attention, because it's not just these businesses saying that the 401(k) needs fixing.
For years pension experts have worried that 401(k)s put too much emphasis on the investing process, do too little to help people plan for the income they'll need, and allow participants to be too aggressive during market rallies or too cautious after crashes.
Understanding the better mousetraps Booth and his competition are trying to build can teach you how to better save for your retirement, regardless of whether you are in one of these plans.
Here are four seriously bright ideas behind what just might be the 401(k) of the future.
BRIGHT IDEA NO. 1: You won't win by becoming a brilliant investor
It's not that owning good funds is irrelevant. Over the past 15 years, the best-performing large-cap stock fund beat the S&P 500 index by an annualized 6.2 percentage points. If you happened to pick that winner in advance, then, yes, that would have made a big difference.
Trouble is, over the past decade 60% of actively managed U.S. large-cap funds underperformed the S&P, according to S&P Dow Jones Indices. And the noise of the market often drives fund investors to buy and sell at the wrong times.
From 2000 to 2009 the average fund earned an annual 3.2%. Morningstar data show the return to the shareholders -- measured by tracking money flows in and out -- was about half as much.
You can work to getting better at investing, but the evidence is that this won't get you far. For some savers, farming out investment choices would be a relief.
"The majority of 401(k) participants are not particularly informed about investing decisions, nor are they very interested," says Christopher Jones, chief investment officer at Financial Engines.
For those used to playing a more active role, though, taking a hands-off approach might not be so easy. Managed plans are generally take it or leave it: You can't swap some of their picks for your own ideas. And you have to pay for the service. Some advisers charge up to 0.6% on top of fund costs; Dimensional uses its own broadly diversified portfolios and charges a flat 0.6%. (That's besides other possible 401(k) costs for things like record keeping.)
Although the managed services pick the funds you'll hold, Financial Engines and GuidedChoice do allow you to change your exposure to stocks depending on your comfort level. At the same time, their calculators instantly show how raising your risk could lower your income if markets are poor.
Dimensional takes a more radical approach: It never asks about your appetite for risk. It sets an asset allocation it calculates will give you the best shot at hitting your income goals -- a strategy that will vary depending on your savings and time to retirement.
Dimensional thinks risk tolerance is too wobbly a concept. When stocks soar, everyone has a stomach for risk; after losses, many aggressive investors realize that they want out.
"If people answered risk questionnaires accurately, no one would be in equities," says Michael Lane, head of Dimensional's retirement business. "We don't ask questions that at the end of the day don't matter."
Do it on your own: If you can't, or won't, turn over control of your money, train yourself to mess with it less often. One way to do that is to not stray too far from a moderate asset allocation, perhaps an age-based rule like 100 or 110 minus your age in stocks. That way when the market crashes, you're less likely to be gripped by an urgent need to act.
BRIGHT IDEA NO. 2: It's not about hitting "the number"
The way you measure success in a standard 401(k) plan is by getting as close as you can to a savings target, a.k.a. your "number."
Mathematically there's nothing wrong with setting a number. Psychologically, though, it's far too fuzzy: What looks like a huge stash may not be enough to produce the income you need. "Even $1 million doesn't go that far anymore," says Olivia Mitchell, a pensions expert at the University of Pennsylvania.
Following the popular 4% rule of thumb would leave you with an initial income of $40,000. Not bad, but even with Social Security thrown in, it may not be living large for someone with a six-figure income before retirement.
On the other hand, some online retirement calculators spit out targets so seemingly high that younger savers could despair of ever reaching them. "We need to get the focus off of cash piles and onto cash flows," says Alicia Munnell of the Center for Retirement Research at Boston College.
The new 401(k) plans constantly track your progress in terms of your likely income in retirement. For example, you might see a dollar range based on your current savings habits, planned retirement age, and Social Security benefit. They also help you estimate how much you'll need.
Dimensional, for example, separates that into two buckets: money you need to cover essential costs, like food and health care premiums, and funds for luxuries, such as an annual vacation. That distinction becomes especially important late in your career, as Dimensional decides how much risk to take with your portfolio. (See bright idea No. 4.)
If you have less than a 15% probability of achieving your desired income goal, Dimensional's software could even force you to alter your plan -- by saving more, for example, or accepting a lower future income or later retirement.
But Sherrie Grabot, CEO of GuidedChoice, says that even the simple exercise of showing savers how much income their nest egg will probably generate is powerful. "People understand how much their monthly bills are," she says. "If the numbers don't match up, they know they can't afford to retire. They get it."
Do it on your own: Managed 401(k) plans generally try to get you to between 70% and 80% of your pre-retirement income, including Social Security.
The free Retirement Income Calculator on the website of T. Rowe Price sets a 75% goal, and is a good way to get a ballpark estimate. If you want to depend less on market fortunes, try plugging in a conservative portfolio, rather than T. Rowe's suggested allocation, and see how much you'