MONEY 401(k)s

Are You a Saver or an Investor? It Matters in a 401(k)

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Most 401(k) participants see themselves as savers, new research shows. And it's holding them back.

The venerable 401(k) plan has many failings and is ill suited as a primary retirement savings vehicle. Yet it could do so much more if only workers understood how to best use it.

The vast majority of 401(k) plan participants view themselves as savers, not investors, according to new research. As such, they are less likely to allocate money to 401(k) plan options that will provide the long-term growth they need to retire in comfort.

Only 22% of workers in a 401(k) plan in the U.S., U.K. and Ireland say they are knowledgeable about investing, State Street Global Advisors found. This translates into a low tolerance for risk: only 27% in the U.S., 15% in the U.K., and 10% in Ireland say they are willing to take greater risk to achieve better returns.

This in turn leads to sinking retirement confidence. Only 31% in the U.S., 26% in the U.K., and 16% in Ireland feel they will save enough in their 401(k) plan to fund a comfortable retirement, the survey shows.

The faults of 401(k) plans are well documented and range from uncertain returns to high fees to failing to provide guaranteed lifetime income. Economic activists like Teresa Ghilarducci, a professor of economics at the New School and author of When I’m Sixty-Four, have been arguing for years that we need to return to something like the traditional pension.

But the switch to 401(k) plans from traditional pensions has taken more than three decades. A broad reversal will be slow too, if it comes at all. In the meantime, workers need to understand how to best use their 401(k) or other employer-sponsored defined contribution plan. Like it or not, these plans have become our de facto primary retirement savings vehicles.

At a basic level, plan participants of all ages must begin to embrace higher risk in return for higher rewards. The State Street survey reveals broad under-exposure to stocks, which historically have provided the highest long-term returns. A popular rule of thumb is to subtract your age from 110 to determine your allocation to stocks. But the latest research suggests that even just a few years from retirement you are better off holding more stocks.

There is much more to making the most of your 401(k) plan than just adding risk. You need to contribute enough to capture the full employer match and be well diversified, among other things. But it all starts with understanding that saving in a secure fixed-income product is not investing, and it is not enough to get you to the promised land.

Yes, the financial crisis is still fresh and the market’s deep plunge is an all-too-real reminder that stocks have risk. But just five years later the market has fully recovered, and 401(k) balances have never been plumper. Fixate on the recovery, not the downturn. A diversified stock portfolio almost never loses money over a 10-year period. It took the Great Depression and then the Great Recession to produce 10-year losses, which were less than 5% and disappeared quickly in the recovery.

If you feel nervous about investing in stocks, consider opting for a target-date retirement fund, which will give you an asset mix that shifts to become more conservative as you near retirement. While they may not suit everyone, target-date funds tend to outperform most do-it-yourselfers, research shows. With your asset mix on cruise control, you can focus on saving, which is enough of a challenge.

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