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401(k) Investing -- First Get the Facts

Vern Hayden

The financial question I have been asked most often this year is: How should I invest my 401(k) money?

The kaleidoscope may have been invented to reflect the variety of 401(k) plans available. There are good plans and there are bad plans. TSC's Alison Moore wrote a very illuminating column on 401(k) plans. I am going to address something a little different.

Whether you're stuck with the old single-family load funds or the newer no-load plan with up to 56 funds to select from, you have to make decisions. These decisions aren't easy to make, especially since you're busy scratching out a living. There are very few companies providing guidance or educational sessions on how to invest the money you put in. In today's column and next week, I will focus on just that issue -- the investment decision.

Obviously, I cannot make specific recommendations because I don't know your situation. Securities laws also prevent me from helping you with specifics by email. Consequently, I will take you through the steps to arrive at a good decision.

Step 1.It all starts with your decision to participate. You have to be in the game to play it. Always try to put the maximum in, at least up to the amount your company will match. If you're not participating, set a date when you will start!

Step 2. Write up a paragraph or two on your investment objectives. In the business we call this an investment policy statement. The 401(k) plan itself is supposed to have an IPS. Ask your employee benefit coordinator for a copy. It should explain the how, why and what of picking investments for the entire plan. Your personal statement should cover the following: the amount you will contribute, how much risk you can take, the length of time you will be participating, the approximate amount you will allocate to defensive and offensive funds, criteria for picking the investment and changes in your selection. In other words, define your objectives with the plan.

Step 3. It helps to visualize the result of your efforts. Project a couple of examples for yourself just to have a feel for the possibilities of accumulating a nest egg. For many people, 401(k) plan investments will represent the primary source of savings and investing. For instance, take a look at what you can accumulate if you invest the following amounts every month for 20 years:

Your Retirement Plan After 20 Years Monthly investment $300 $600 At 8% $176,706 $353,412 At 10% $227,810 $466,621 At 12% $296,776 $593,553 Total principal investment $72,000 $144,000

Source: Vern Hayden

As you go about living every day, it feels good to occasionally think, "At age 55, I'll have about $400,000 in my 401(k)." It makes it a lot easier to look at that deduction on your pay stub.

Step 4. Obtain all the information you can on your investment choices. (Sometimes the company administering the plan or providing the investments has the information.) You should get the following information:

• The name of the funds.

• The manager's name -- not just "Fidelity," but the name of the person managing the fund.

• How long has the manager been with the fund? If it has been a short time, where was the manager before?

• What is the manager's philosophy: growth, value or a blend of the two? A growth focus is on an increase in earnings and the growth rate of a company. A value manager will try to find beaten down, undervalued stocks of companies that are basically sound and high quality. These managers want a dollar's worth for 50 cents. A manager using a blend approach is simply combining the two.

• What is the manager's track record? (Not just the fund's track record.) Try to get a long-term performance record, even if with another fund. Check out 1987, 1990, 1994 and 1998. These were years of down markets.

• Identify a category for each equity fund. These categories include the investment philosophy of the manager -- growth, value or blend -- and the size of the companies the fund invests in: A small company is one with up to $1 billion of market capitalization. Market cap is determined by multiplying the outstanding number of shares by the current share price. A medium-size company has a market cap of $1 billion to $5 billion. Large companies have market caps of more than $5 billion. Combining the different philosophies will give you such categories as large value, medium growth and small blend. These categories will at least give you a general "feel" for the funds' behavior.

• Morningstar has a star rating system that goes from 1 (worst) to 5 (best). You shouldn't select a fund just based on a star rating, but generally a good manager will have a 4- or 5-star rating.

Step 5. Identify the asset class for each fund. They include:

• Money market funds.

• GICs, or guaranteed insurance contracts that offer a yearly interest rate.

• Bond funds. These can be short-term, intermediate or long-term. If one says "high yield" it's probably a junk-bond fund that will behave more like an equity fund.

• Stock funds.

• Hybrid funds. These are funds that can invest in stocks and bonds

The rest of the steps next week. Have a great holiday! I would be interested in knowing how many of you have access to a 401(k) and any general questions you may wish to see addressed in next week's column. Please email me your feedback. Thanks!

Vern Hayden is a certified financial planner with the American Planning Group in Westport, Conn. His column is not a recommendation to buy or sell stocks or to solicit transactions or clients. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks or funds. Hayden welcomes your feedback.