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Is Human Nature Hurting Your 401(k)?

I recently attended Pension & Investment Magazine's 401(k) Investment Lineup Summit here in Chicago. There were a number of speakers who gave excellent talks on various aspects of building a 401(k) lineup. One of the best was a University of Chicago professor who cited some of the behavioral factors that often prevent plan participants from achieving a successful outcome.

Individuals are extremely averse to losses. The professor led us through several exercises that demonstrated this principle. The implication for 401(k) investors is that in many cases they focus too much on the risk of loss as opposed to focusing on taking an appropriate level of risk in line with the level of assets they need to accumulate to fund their retirement goals. In many cases, participants are still spooked by the losses they incurred in the 2008-09 market decline.

Choice conflict leads to choice avoidance. Translated, this means that having too many choices often leads to inaction. This is all too true in the 401(k) world. Many plans offer too many investment choices, leading participants to do nothing. Plan participants often feel overwhelmed by having to direct their own investments. Add a large number of choices and you have a formula for inaction. In today's world, this often means that many participants are defaulted to a target-date fund or some other default option. This may or may not be the appropriate choice for their situation.

Inertia is the norm. According to the professor, most employees have the same asset allocation as the day they started work. As an adviser to a number of plans, this has been my experience as well. Participants rarely change their allocations, even as they age. If fund A is replaced in the lineup by fund B, you rarely see money move into or out of the new fund. An allocation that was appropriate at 35 is likely not appropriate for that participant at age 55.

Taking charge of our own retirement savings and investing is a daunting task. If you see the traits outlined above in yourself, consider some ways to take charge of your 401(k) plan:

--Consider using an advice option if offered by your plan. This might be in the form of online advice, via telephone, or in person.

--Managed accounts, which generally allocate the plan's existing funds into portfolios that fit various levels of risk, are gaining in popularity.

--Engage the services of a financial adviser. A professional should take a broad view of your overall financial situation and advise you on how to invest your 401(k) account as part of that process.

Note these will all generally involve a fee of some sort. No-charge options might include using a target-date fund or a balanced fund if available in your plan. A balanced fund will typically have a fixed allocation--often 60 percent stocks and 40 percent fixed income.

A target-date fund is generally a fund of the funds of the company offering the fund (Vanguard, Fidelity, and T. Rowe Price have about 80 percent of the total target-date fund assets between them). The idea is to manage the fund to the retirement target date of the fund and then offer a glide path into retirement in most cases. A good idea, however even these funds require review and evaluation by the investor to determine if they are the right solution. They do, however, offer professional management.

Managing your 401(k) is not easy to begin with. Human nature doesn't make the task any easier.

Roger Wohlner, CFP®, is a fee-only financial adviser at Asset Strategy Consultants based in Arlington Heights, Ill., where he provides advice to individual clients, retirement plan sponsors, foundations, and endowments. Read more about Roger here.

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