Whether you like it or not, an Automatic Enrollment 401(k) Plan is a good thing. Everyone knows the importance of saving and investing wisely in your future. Making people choose “not to save,” instead of “to save” gets people past the initial uncertainty and questions when entering a 401(k) plan.
We no longer hear people say “Let me take this home and think about it.” With Automatic Enrollment, the questions become “What should I invest in?” or “How often should I be checking this?” Participants want to maximize performance but they don’t want to be too “hands-on.” Striking a healthy balance can be done with little difficulty.
Auto-enrollment offers a great opportunity
Because pensions are no longer common, employers have started automatically enrolling employees in 401(k) programs as a way to increase participation and help employees begin saving. It’s a great tool and a wonderful opportunity for them to prepare for retirement.
The question soon arises, “Can I leave my plan on cruise control, or do I need to take charge and pay close attention?” It’s a fair question. It’s tempting to take the “set it and forget it” approach. But is that the right thing to do? Can you trust the system to do what you want?
Default settings are convenient
Each 401K plan has its own default settings, most of which are designed to match your age. The idea is to automatically reduce risk as you approach retirement. Risk is managed by gradually moving assets away from stocks and into bonds. Stocks offer more growth but are typically more volatile. Bonds offer more long term stability but less upside potential.
Using these automatic settings is convenient. Consider these points:
- Typically at age 30, an employee would likely be placed in a Target Date 2050 fund
- That fund is normally a 90% stock to 10% bond portfolio
- Automatic rebalancing will adjust to your age, reducing your risk
Larger companies (over 5,000 employees) like to offer this approach, as many employees may not have access to a wealth advisor.
Convenience has its price
Convenience is great, but rarely in life does one size fit all. And so it is in retirement planning. Using an automated approach does not take into account a person’s situation and personality.
Take Sarah, for example, an accomplished professional. At 30 years old she’s doing well in her career with a bright future ahead of her. Although she’s taken risks in her workplace, she doesn’t have the stomach for the typical ratio of 90% equities and 10% bonds.
In fact, the same is true of many of her associates. Actually, fewer than 5% of our clients choose the 90/10 portfolio. When we meet individually with a plan participant to evaluate their risk tolerance and construct a plan based on that risk tolerance, most people end up middle of the road with either a 60/40 or 50/50 portfolio.
What that tells us is that automatic settings rarely reflect the right approach for investors. What it also tells us is that people like Sarah need to get involved in their portfolio management on some level.
Right size your involvement
Life gets busy. People get married, have kids and find themselves in the frenetic pace of living, loving and having fun. Few have the desire to pay enough detailed attention to their portfolio to maximize the performance of their investments. Fewer still have the expertise.
Sticking your head in the sand won’t maximize your results, but spending endless hours in research, buying, selling and worrying isn’t what you signed up for either. After all, it’s about your resources serving you well, not the other way around.
Finding the balance between maximizing financial performance and enjoying life is easily done with the help of a financial planning professional.
Work with a wealth planning professional
I typically start with questions about my client, their goals and their current situation. We then map out a plan that fits them and then review what’s happening on an annual basis. As their situation changes with work, marriage and children, we review the plan and make adjustments as needed.
This is how people enjoy the greatest benefits of their 401(k) auto-enrollment program while navigating the sometimes turbulent waters of investing.
Keep asking questions
Retirement planning can be as simple or complex as you choose to make it. I have found that active investors typically get better results. And staying active starts by asking good questions, as I’ll explore in a follow-up article. Stay tuned for more information on this important topic.