Recently, a client came in for his annual review, going over his current financial planning strategy and goals. As part of the review, he brought in his 401(k) statements and we discovered while his investment performance was stellar, his allocation was very far out of line with his financial plan.
Typically in a 401(k), investment options are limited to a specific set of mutual funds or exchange-traded funds. As part of a comprehensive review, investment advisers typically provide recommendations, helping investors pick the funds that best fit into their financial plan. Unfortunately, many investors take these recommendations as “set-and-forget,” because this is long-term retirement money.
However, these recommendations are based on a snapshot in time and current information. Quite often, these mutual funds pay dividends, which are then reinvested into more shares of the same mutual fund. Between normal market performance and reinvestment of dividends, an investor’s 401(k) allocation can easily become skewed. For example, let’s say you were provided an allocation of 60% Large Cap funds, 30% Small- and Mid-Cap funds, and 10% International funds. Last year, Large Caps gained 11.5%, while Small and Mid-Caps gained more than double that. After a year, your Small/Mid Cap allocation is now about 32% of your 401(k) investment. With dividends reinvested, this could be closer to 35%. While it is common for Small- and Mid-Cap investments to outperform, they also come with more volatility, and that can mean more risk for funds that are meant for your retirement. This may be good during an upswing, but if the market were to have a negative year, you could see a much larger decline.
When we manage a client’s assets, we typically look at their traditional and Roth IRAs, brokerage accounts and trusts, etc. We develop an allocation that takes into consideration a recommended allocation for their 401(k). For accounts we have discretionary control, we do not automatically reinvest dividends—rather as they accumulate, we are able to pick where to invest the money, which allows us to keep true to an allocation that we agreed upon or take advantage of good buying opportunities. However, because holding dividends in cash generally isn’t an option in a 401(k), it is the investor’s responsibility to monitor and rebalance their 401(k) portfolio as needed.
Because so many investors have a majority of their retirement money in their 401(k), we began offering active management for 401(k) accounts. When managing a client’s 401(k), the planning team performs a monthly review, checking if investment options have changed; how investments have performed, and if the current allocation still meets the needs of the investor’s overall financial goals, etc. With increased fiduciary regulations, advisers may be hesitant to provide recommendations on assets they cannot monitor and manage. Actively managed 401(k) services allow us to follow through on our fiduciary responsibility.
Some 401(k) plans will offer an automatic rebalancing feature that a participant can set to keep allocations in line with initial recommendations. This may work if your overall strategy stays the same, but as life events happen and as you get closer to retirement, your financial plan has to adapt. This includes how your 401(k) is allocated. Nothing should be considered a set-and-forget investment.
If you have questions regarding how your 401(k) allocation should fit in your overall financial plan, the experts at Henssler Financial will be glad to help:
- Experts Request Form
- Email: experts@henssler.com
- Phone: 770-429-9166.
This article is meant to provide valuable background information on particular investments, NOT a recommendation to buy. The investments referenced within this article may currently be traded by Henssler Financial. All material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. The contents are intended for general information purposes only. Information provided should not be the sole basis in making any decisions and is not intended to replace the advice of a qualified professional, such as a tax consultant, insurance adviser or attorney. Although this material is designed to provide accurate and authoritative information with respect to the subject matter, it may not apply in all situations. Readers are urged to consult with their adviser concerning specific situations and questions. This is not to be construed as an offer to buy or sell any financial instruments. It is not our intention to state, indicate or imply in any manner that current or past results are indicative of future profitability or expectations. As with all investments, there are associated inherent risks. Please obtain and review all financial material carefully before investing. Henssler is not licensed to offer or sell insurance products, and this overview is not to be construed as an offer to purchase any insurance products.
