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How Your Employer Is Ruining Your Retirement

Wednesday - 2/6/2013, 6:21pm  ET

It's not exactly news that a majority of Americans are vastly unprepared for retirement. In fact, a new survey conducted by TD AMERITRADE shows that the average baby boomer is about half a million dollars short on retirement savings. It's hard enough to sock enough away cash for your golden years with all the other demands on your pocketbook, but now it looks like even your employer may be making the process more difficult.

Research from the Center for Retirement Research at Boston College reveals that employers that administer 401(k) plans tend to suffer from performance-chasing, or picking funds for the company's retirement plan based on how well the funds have performed in the past few years, not over the long run. The analysis shows that in the time period studied, administrators dropped 45 underperforming funds from their plan menus and added 215 outperforming funds. Unfortunately, this performance differential did not persist. After the change was made, the added funds lost most of their performance advantage compared to a group of random similarly managed funds while the dropped funds improved, outperforming the random group of funds. These results seem to indicate that employers are making adjustments to the array of funds available to their employees based on recent performance, but these changes are not actually helping improve performance for plan participants.

So what's a 401(k) investor to do? Here are four steps to take to ensure you make the most of your retirement plan:

1. Contribute enough to get your employer match. 
Even if your retirement plan is full of subpar, high-fee mutual funds or you have only a limited selection of funds to choose from, that's not an excuse to opt out of participating. Make sure you're still contributing enough to your plan to capture the full employer match. Not taking advantage of that match is like leaving free money on the table. If your 401(k) plan is truly dismal, once you've got the employer match, think about setting up a separate IRA where you'll have greater freedom in selecting your investments.

2. Don't chase performance on your own time.
It's hard not to be attracted to those funds that have posted hot recent returns, but you can't fall prey to performance-chasing, especially since your employer has likely already taken care of that for you! Don't add another layer of rearview-mirror investing to the mix. Instead of allocating your dollars based on short-term past performance, look for those funds with low expenses, long-tenured managers or management teams, and solid long-term performance in both good and bad market environments. Any manager can look like a genius for a year or two, but the funds with staying power are the ones that can do so consistently over time, no matter what the market is doing.

3. Get the asset allocation question right.
Studies have shown that asset allocation, or how you split up your money among stocks, bonds, and other investments, actually has a greater impact on your investment results than the specific stocks or funds you choose. Even if you don't have the best selection of funds available to you, try to get your asset allocation as close to your target as possible with the funds you do have to pick from. Investors with several decades left until retirement should target a 95%-5% stock-bond mix, while folks with fewer than 10 years until retirement should aim for a 75%-25% allocation. Retirees may be more comfortable with a 60%-40% stock-bond mix.

4. See if your plan has a self-directed option.
More and more 401(k) plans are offering plan participants the option to "self-direct" their account. If your plan offers this option, you can basically invest your 401(k) money in a separate brokerage account with a wider array of stocks and funds to pick from. Just remember that a self-directed 401(k) isn't a license to engage in frequent trading -- you're investing for the long run, so make your trading decisions accordingly.

If you do have the option for a self-directed account, you may want to consider some relatively inexpensive exchange-traded funds to complement the other actively managed funds you may already hold. Think about funds like Vanguard Total Stock Market ETF or SPDR S&P 500 ETF for large-cap exposure. Or consider an option such as Vanguard Small-Cap ETF  to boost your exposure to smaller companies. 

If you're looking for complete foreign exposure in your account, Vanguard Total International Stock ETF is a good choice. Looking for a broad fixed income allocation instead? Vanguard Total Bond Market ETF makes a solid option.

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