MONEY

The Market Boomed… and 401(k) Investors Sat on Their Hands

A new survey out today from Hewitt Associates finds that 401(k) investors haven’t been very busy lately. Just 16% of participants made any kind of fund transfer in 2009, vs. about 20% the year earlier. In other words, relatively few people noticed the 27%-return rally in the works and said to themselves, “Hey, I should jump back into stock funds.” That’s good… and it’s bad. And it’s an opportunity to make 401(k)s work better.

Why it’s good: Chasing hot-performing funds or sectors is a pretty-sure fire way to lower your return. But the majority of investors didn’t do that.

Why it’s bad: As Hewitt notes, the numbers also mean that the majority of investors didn’t move to rebalance their portfolios. That means that as the value of the stocks in their portfolio grew, they were more exposed to equities (as a percentage of their overall portfolio) at the end of the year than they were at the beginning. Trimming back on stocks to get back to your original asset allocation can help reduce risk, and it gives your portfolio a slight (and smart) contrarian tilt, because it forces you to sell what’s hot and buy what’s not.

How to make 401(k)s better: If employers and policymakers want people to get more out of their 401(k)s, investors who underreact aren’t as big a problem as investors who overreact. It’s hard to convince someone who thinks that frequent trading is helping his return that he’s wrong about that — although he probably is. But for most investors, it seems, inertia plays a huge role in their investment decisions (or, more precisely, their non-decisions). That suggests that you can do a lot of good just by nudging people into low-cost, well-diversified investments at the very beginning.

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