Be Passive, Rather Than Active, With Your 401(k) Plan

By Clifton Linton
Writer, 401k Forum

Gary Tsalalikhin, 24, uses his computer network designing skills to boost the performance of his retirement portfolio. He wired his computer to show real-time stock quotes.

"I've got a ticker running," he said. "Every point means a significant amount of money up or down."

With an eye constantly on the market, he frequently adjusts his portfolio based on what he sees on the screen. In 1999, his portfolio, largely concentrated in one stock, has earned a return of more than 1,000%. When we spoke with him Wednesday, Oct. 20, the portfolio was worth $560,000, down $40,000 from Tuesday. His strategy isn't "low stress," he admits.

Over the past few years, it seems nearly everyone is making a killing in the stock market. That has spurred some, like Tsalalikhin, to actively manage their retirement funds. It's caused others to wonder if taking a more passive approach is right.

In many plans, it's now easier than ever to change your portfolio. You can hop on the Internet to check closing quotes and then call funds 24-hour toll-free numbers to change allocations. According to the Profit Sharing/401(k) Council of America, plans permitting daily fund transfers rose from 61.3% in 1997 to 71.3% in 1999.

But, do you really need this instant access? Should you turn over your retirement funds almost daily?

No, say experts. They offer several prudent strategies to follow so that you can do as well as, or better than, the fussbudgets.

Keep A Long-Term Perspective

Planning for retirement is more like figuring out how to run a marathon than a sprint.

"You should keep … a long-term perspective," said Paul Katzeff, a reporter with Investor's Business Daily and author of Getting Started in 401(k) Investing. "That means you shouldn't trade out of funds on a day-to-day basis for fleeting fluctuations. That dooms most people to a lagging performance."

That's the approach 23-year old investment-banking analyst Linda Chun uses. Her job gives her fantastic access to financial news, but she doesn't pay attention. She sticks with a longer view. "Even if I lost a dollar, (the funds) were doing fine over the long term," she said.

Katzeff says managing funds day to day might cause you to miss big moves. From 1981 to 1998 the widely watched S&P 500 index earned, on average, 21% annually. This benchmark is a market-weighted index of 500 companies considered the leaders in their sector of the economy. If you were day-trading your retirement account over that time and missed the index's 10 best days, your return would fall to 16% annually, Katzeff says.

Tsalalikhin wants to retire early and that's why he's taking such a high-risk approach. But, he knows even if his portfolio gets wiped out he has enough time to start all over and build a respectable portfolio, he said.

Invest In Mutual Funds

Most people aren't skilled enough to actively manage their portfolios.

That's why you should invest your 401(k) money in mutual funds, so you get the benefit of professional money managers' expertise. Let those guys sweat the details, urges Scott Lummer, chief investment officer at 401kForum.

"Investing is different than any other profession," he said.

It's different from the physical world, which often acts in a predictable, linear way, he explains. Say you're an airplane pilot. If your plane is cruising at 25,000 feet and falls 10,000 feet, you know you need to fix the situation. If you don't the plane will crash. But at the same time you know you still have 15,000 feet of altitude left to work on the problem.

The stock market doesn't have such obvious behavior. Sometimes a one-day decline is followed by a three-day rally. Sometimes the decline lasts a week. Who knows how long rallies or declines will last? Hours, days, months? Just because the market is strong today, doesn't mean it will be strong tomorrow.

The professional money managers have the experience and skills to interpret market moves and figure out when to stay with the trends or bail out.

Another benefit of mutual funds is diversification. Tsalalikhin, who is directing his own retirement plan rather than using a 401(k), is primarily invested in one high-performing stock. If that company or its peer group takes a tumble, there goes his entire retirement stake.

On the other hand, if you invest in a broad-market growth or value fund, such a hit will be offset by the fund's other investments. Most folks don't need to worry about choosing individual stocks because most 401(k) plans don't allow investments in individual stocks, aside from employer's stock.

One caveat: if the entire market takes a tumble, your portfolio will likely suffer as well. But, that's only in the short term.

Review Your Account Once A Year

One way to distance yourself from the emotional roller coaster that can accompany trying to time the market is to review your allocations once a year.

Save your quarterly statements and review them at year end, Lummer suggests.

 Then, make sure that the funds you picked are still strong performers.

This is also the time to read the prospectus that all fund companies mail yearly to investors. A prospectus explains the fund's investment philosophy, who runs the fund and the fund's annual expenses.

Another important document to read is the sales-wrapper that comes with the prospectus. It shows the fund's current share holdings. This document can tell whether the fund manager is sticking to the investment philosophy.

Sometimes they don't. In 1996, Fidelity Investment's famous Magellan fund came under harsh criticism when then-fund manager Jeffrey Vinik reported that about 20% of the fund's holdings were invested in Treasury bonds. While fund rules let Vinik invest in bonds, the news still upset many shareholders. They bought fund shares expecting their money would be invested in the stock market.

Every decade, as you get closer to retirement age, you should consider making a major shift in your strategy.

Keep Up With The News On Your Funds

In early October, news surfaced that the portfolio manager, chief investment officer and entire equity team left Evergreen's Select Special Equity I fund. Suppose you were invested in that fund. The loss of such a key group should raise the question of how the fund will perform without leadership.

In keeping up with the news on your funds you want to be alert to news of larger than usual returns, larger than usual declines and significant changes in both the individual fund as well as fund family management.

The news might spur you to at the least keep a closer eye on that fund, or you might want to stop investing money in the fund. At the worst you might want to pull all of your money out of the fund.

For fund and market news, you can start with the business section of your local paper. Many investors read the Wall Street Journal's thorough fund industry coverage as well. There are many online resources as well. (See sidebar.)

Researching on your own, you won't have the information as fast as the professionals, but you'll stay on top of things. And, you'll be able to make informed decisions, hopefully before things get out of hand.

Increasingly, employers are offering advice services to their employees. Check with your Human Resources office to see what's available for you.

Fight Emotion. Make Shrewd, Logical Choices

Most investors panic and tend to sell their fund when it's doing poorly and put their money into another doing less poorly. It turns into a "buy high, sell low strategy," Lummer said. "We tend to make dumb decisions based on emotion."

One thing to keep an eye on: how is your fund performing compared to relevant benchmarks? Say you invest in a large-cap growth stock fund benchmarked to the S&P 500 index. Further suppose that over a one-year period, the index posted a 4% annual return. Finally, suppose your fund posted a 10% return. Even though it's great news, it could be a sign of trouble, Lummer says.

"If the fund's up 10% while the market's only up 4%, (the fund) could be taking undue risk. As many times as not, that risk won't pay off," he said.

The information provided here is intended to help you understand the general issue and does not constitute any tax, investment or legal advice. Consult your financial, tax or legal advisor regarding your own unique situation and your company's benefits representative for rules specific to your plan.

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