6/8/2012 5:10 PM ET|
Disappointing 401k? Take control
Chances are good the funds in your 401k yield only about 2%. A self-directed plan filled with dividend stocks can do much better.
This may surprise you, but there's a good chance you can take direct control of your nest egg at work, choosing investments beyond the two dozen or so mutual funds that most employers offer in their savings plans. Doing so can be risky, but here's why you should consider taking a shot at it.
About one in five employers, according to Plan Sponsor Council of America (PSCA), offers a self-directed brokerage option, in which workers with 401k's and related accounts can buy stocks, bonds and other assets. Also, three-quarters of employers -- and 86% of those with 5,000 or more plan participants -- permit "in-service withdrawals" (typically starting at age 59-1/2), where holdings can be pulled from accounts and rolled into IRAs.
Yes, this is a scary idea: people taking the wheel of their savings plans and, possibly, crashing into crazy investments. Most workers with these options, in fact, take a pass; less than 1% of plan assets are invested through self-directed accounts. Indeed, according to David Wray, president of PSCA, "401k participants are not retail investors -- picking individual stocks is way out of their thinking."
But I'm betting that, if you pursue either option, you're smart enough to do so gingerly. In which case, the potential payoff is that you get a jump on building income for retirement.
More people recognize the importance of having investments that generate cash in later life. That way, you aren't dependent on capital gains to meet expenses. What's less appreciated, though, is the value in identifying and assembling these investments early -- say, five or 10 years before retirement. If you can get a head start on building income at age 55 or 60, says Charles Farrell, chief executive at Northstar Investment Advisors in Denver, the compounding effects can move you closer to the point where you're living off the returns of your portfolio in retirement, rather than eating into the portfolio itself.
Dividend-paying stocks -- and an important concept called "yield on cost" -- are a good example of how this can work. Yield on cost is calculated by dividing a stock's current dividend by the amount originally paid for each share. Let's say you buy a stock for $12, and it pays a 3% annual dividend, or 36 cents. And let's say that after a year, the share price hits $16, and the company increases the dividend to 48 cents.
At this point, the payout is still 3% (48 cents is 3% of $16). But not for you. You paid $12 for your stock; thus, you're getting a dividend of 48 cents on $12 -- or 4%. So, your yield on cost is 4%. In other words, you're now earning a higher yield on your original investment, which puts more money in your pocket. If you're able to invest in companies with a long history of paying dividends -- where those dividends increase annually and the increases outpace inflation -- your yield on cost eventually should outshine the return on other investments.
Now, let's return to your 401k, which likely holds the bulk of your retirement savings. Chances are good that the mutual funds in your account are yielding about 2% (or less) -- hardly the stuff of retirement dreams. (Inflation alone is running about 2.9%.) But if you could gain access to a wide range of investments, you could assemble -- today -- a group of dividend-paying stocks (again, with a steady history of payouts and dividend increases) that yields about 3.5%. Ideally, over time your yield on cost on these shares would rise significantly.
To see how this might work, I asked Charles Carnevale, founder of FAST Graphs, a website with a nifty set of stock-research tools, to calculate how yield on cost for several investments could change over time, based on analysts' current growth estimates. I picked Coca-Cola (KO), Johnson & Johnson (JNJ) and Procter & Gamble (PG), each of which meets our criteria: an attractive current yield and a history of increasing payouts.
At the moment, the three stocks yield roughly 3%, 3.6% and 3.2%, respectively. In five years, the yield on cost for these stocks -- again, based on the companies' projected growth -- is expected to reach 4.6%, 4.7% and 4.8%. In five more years (should the current growth rate hold), the yield on cost for each would exceed 6%.
How could this help you? Remember: A 4% rate of withdrawal from a nest egg is traditionally considered a safe starting point. If you're thinking about drawing down your savings at that rate, "the growing yield on cost alone may meet your distribution needs in retirement," says Farrell.
If all this sounds too easy, you're right to be cautious. Dividends, of course, can be reduced or eliminated. In 2008, Bank of America's (BAC) quarterly payout was 64 cents; today it's a penny. Companies don't always meet growth estimates. And some people simply aren't meant to manage their money: They buy and sell too frequently; they pick less-than-stellar investments (read: Enron); and they get hammered with trading fees.
That said, the need for dependable and growing income in later life is clear -- and if you can start the process early, so much the better. My advice: See what options you have with your 401k. If you're able to take the reins, sit down with a financial adviser and discuss investments that fit your comfort level and future needs. The ride could be safer than you think.
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Sadly, most people don't do anything with their 401K for the years, so it tends to build slowly or worse just track along with the company stock it mainly consists of. In early 2001 we had a significant stock retraction. Those on auto-pilot lost a lot. Some of us figured out that executives switched money to a [capital] preservation option during higher risk periods. They were in stock when the price was rising and in preservation once they sold high, so they could buy low. If it sounds like work, consider that a reward exists. 3 years after the retraction and following that discipline, we had not only recovered our losses but were up more than 200%. Am I advocating everyone doing what we did? No. What I am saying is-- it's YOUR money in that 401K. Wake up, know your options, watch for trends and build a rhythm that generates a favorable return. Anyone can be pro-active.
Unusual article because nobody ever talks about self-directed 401k's. I always felt it was the industry's best kept secrets.
The key word to your article is...IF you could gain access to a wide range of investments! Many 401's don't allow you that kind of access. And, many people are quite passive with their investing allowing their money to stagnate in underperforming funds.
It takes a lot of diligence to manage one's portfolio. Many people don't have the interest or know how to take the time to see what their money is doing.
Stocks are a nice place to park your money but you have to learn which stocks are more solid than other and this again takes a lot of investigating.
It is a good article in that perhaps it will inspire more people to take more of an active roll in their investments.
I wish the ROTH had been available when I worked. Alas, it wasn't.
On another 401(k) issue, people are now told not to invest everything in their company stock, but that was way before Enron, etal. So I did, and am I glad! The plan became available the last thirteen years I worked, and my company's stock gained almost every quarter the entire time. I realize now how badly it could have turned out, but as it is I am very thankful for my stock which did so well. However, if I heard the works "accounting discrepancy" or "cutting dividend" I'd sell so fast it'd make my head spin.
You really can take control of your 401(k) and it is really not rocket science. I have personally taken advantage of the major swings we have amongst us in these uncertain times. If you seek investments that mimics the major indexes, such as mutual’s that follow the S&P 500, buy low and sell (hide in money markets) high. The major swings will prevail a better net than leaving it sit. The S&P 500 1 year return has yielded a 3.6% Return. I have "CAREFULLY" negotiated the buy/sells and have a current 16% YTD yield. I anticipate my 1 year return to net a healthy 29-30%. Ask your 401(k) advisor what the average return of the plan will give you. It is pretty disappointing.
Also, three-quarters of employers -- and 86% of those with 5,000 or more plan participants -- permit "in-service withdrawals" (typically starting at age 59-1/2), where holdings can be pulled from accounts and rolled into IRAs.
Someone please correct me but I was told by a financial planning company that an individual cannot have an active employer sponsored 401K and a traditional IRA at the same time. I opened a ROTH, which is allowed while still participating in an employer sponsored 401K. My 401K does allow in-service withdrawals but I'm unaware that those withdrawals can be rolled into a IRA.
My mother-in-law's retirement was only gaining interest at a rate of .03 in a IRA account, so someone from church introduced us to an investing idea that allows us to invest, gain interest, and make an income. It takes work, but if you know people that also want to make money and have money to invest is a great idea. A friend from church invested 10,000 and after 90 days he had 66,000 after pulling his 10,000 out. Of course not everyone has that muh to invest as it is the top amount that can be invested, but you can start small. This guy now has 162,000 in his zeekrewards account and 31 affilitates. He is taking out 7,000 a week and his invested is still growing.
Please take the time to vist vvonmerta. zeekrewards. com or http;//vvonmerta.zeekrewards.com
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