Retirement Investing Lessons

The Monday August 4, 2008 Wall Street Journal had an article on the importance of proper investing for retirement. The title of the article was “When 401(k) Investing Goes Bad.” This article talks about West Virginia school employees who 17 years ago shifted from a pension plan with a defined benefit to a 401(k) defined contribution plan.

A defined benefit plan has the employer contributing and having a professional managing the money for retirement with the employer at risk to meet the retirement need. A defined contribution plan typically has the employer matching contributions of the employee and the employee assumes the risk to meet retirement needs.

This is a story that applies to many people. The article states that only 21% of full-time employees have a defined benefit pension plan in 2007 down from 54% in 2004. In 2007, 54 of the largest 100 US employers offered a defined benefit plan down from 58 in 2006.

For the people in the article, things have not gone well for all of the members. One person called it horrible. Most of the members felt poorly informed and they invested too conservatively. Many got guidance from people they knew and trusted who represented a life insurance company over lunch and during school hours. Those giving guidance were just representatives selling a financial product acting in an investment advisory role rather than being a Registered Investment Advisor.

The guidance given was to purchase a fixed rate annuity because it was safe. What happened over time was these annuities could not grow as fast if the money had been diversified and professionally managed in a defined benefit plan. The end result is people not having enough to retire in a manner that they desire or deserve.

The average 401(k) balance for people 60 & above in this group was $34,420. Not enough to replace the benefit from a defined benefit plan.

A couple of other issues are mentioned in the article. Some members did not contribute as much to the plan as would have occurred with the defined benefit plan. Some members took money from their 401(k) plan reducing their retirement account.

As employers move away from defined benefit plans and shift to defined contribution plans the employees have a greater amount of risk. This means people need to understand how much to invest and how to invest to meet a future need. In short they need professional guidance and a retirement plan.

Most investment professionals will choose a defined contribution plan over a defined benefit plan if investing with a long term time horizon because they should get a higher return. However, if a person does not know investing and the ramifications of certain actions, a defined contribution plan can lead to a very low amount of retirement savings.

Bottom Line: If you are in a 401(k) plan and do not feel comfortable about investing, get professional guidance and develop a retirement plan.