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- What kinds of investment
options are usually offered in 401(k) plans?
- Is there a minimum
number of investment options my company is required to offer?
- How should I invest
my money?
- Can I decide how to
invest all of the money in my account, including employer contributions?
- How often should I
receive statements telling me how my investments are doing?
- Is my 401(k) account
protected against investment loss?
- How often can I change
my investment allocations?
- How can I learn more
about the funds offered in my plan?
- What is risk?
- What is risk tolerance?
- What is asset allocation?
- What is diversification?
1. What kinds of investment options are
usually offered in 401(k) plans?
Although
employers are not required to offer any specific investment options,
most choose to comply with voluntary guidelines established by the Department
of Labor. These guidelines stipulate that plans must offer at least
three distinct investment options with substantially different risk/return
objectives.
The
range of investment options commonly offered in 401(k) plans includes:
- money
market funds
- stable
value contracts
- government
bond funds
- income
(bond) funds
- growth
and income funds
- growth
funds
- aggressive
growth funds
- balanced
funds
- index
funds
- international
funds
- life
cycle funds
- company
stock funds
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2. Is there a minimum number of investment
options my company is required to offer?
Legally
there is no minimum, but most employers choose to comply with voluntary
guidelines established by the Department of Labor. These guidelines
stipulate that plans must offer at least three distinct investment options
with substantially different risk/return objectives.
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3. How should I invest my money?
If
you've ever asked your employer this question, you probably found that
no one is really willing to answer it. At best, you may have walked
away with a brochure or an educational tool.
The
reason is this: As plan fiduciary, your employer has to select investment
options for the plan and continue to make sure that these options are
good, prudent investments. By shifting the responsibility for deciding
how the money should be invested to you, the plan participant, plan
sponsors avoid the liability of being held responsible for individual
investments, too. Plan sponsors don't want to give investment advice
because if they do, they could be held liable for the outcome of the
investment allocations they've suggested.
Many
companies are turning to independent advice firms like mPower, the publisher
of this site, to provide investment advice to their 401(k) plan participants.
mPower takes over fiduciary responsibility for the plan and provides
participants with the answers they seek. It's a win-win situation --
participants get personalized investment advice and plan sponsors get
the peace of mind of knowing their 401(k) participants are in good hands.
To
learn more about investment options that are available to you, you could
visit Web sites such as MSN Money (http://moneycentral.msn.com/investor/home.asp),
CBS Marketwatch (http://cbsmarketwatch.com), CNNfn (http://money.cnn.com/),
or Individual Investor Online (http://www.iionline.com).
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4. Can I decide how to invest all of the
money in my account, including employer contributions?
Possibly
not. It depends on the rules of your particular plan. In some plans,
participants decide how their own contributions will be invested, but
the company decides how to invest the matching contributions. In other
plans, employer matching contributions are invested in the same proportions
as the participant contributions. And in some plans, all matching contributions
are made in the form of company stock.
You
should check with your company's human resources or benefits representative
regarding your specific plan.
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5. How often should I receive statements
telling me how my investments are doing?
How
frequently you receive account statements depends on your specific plan.
By law, plans must provide statements at least annually, but some plans
issue statements as often as quarterly, or on demand.
Check
with your human resources or benefits representative to find out how
often your plan provides statements. And remember, plan administrators
usually provide a phone number you can call between statements for information
about your account.
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6. Is my 401(k) account protected against
investment loss?
No.
As with any investment, the money in your 401(k) account is subject
to investment risk (fluctuation in return). How much your 401(k) account
is worth when you retire depends entirely on the amount of your contributions
and the performance of your investments. It is possible to lose money
if your investments do badly.
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7. How often can I change my investment
allocations?
That
depends on the rules of your company's plan. Employers who follow the
Department of Labor's voluntary guidelines must allow transfers among
investments at least quarterly, and more frequently if the plan offers
a very volatile or high-risk investment (one that could fluctuate greatly
over a short period of time, such as employer stock). Beyond the voluntary
guidelines, there is no legal requirement for how often plans must allow
transfers.
How
often your plan allows transfers has a lot to do with how frequently
the plan's record-keeper values the account (reconciles the various
investment gains and losses). Valuations can be performed annually,
semi-annually, quarterly, monthly or even daily -- but you can only
transact business as often as the account is valued.
Currently
a majority of plans value their accounts on a daily basis.
Check
with your human resources, your Summary Plan Description or benefits
representative regarding the rules for your plan.
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8. How can I learn more about the funds
offered in my plan?
There
are almost as many sources of information as there are funds.
First
of all, you can request a fund fact sheet or prospectus, either from
your plan sponsor or directly from the company offering the fund. All
publicly traded mutual funds must have a prospectus.
There
are also some great mutual fund information resources on the Internet,
such as MSN Money (http://moneycentral.msn.com/investor/home.asp), CBS
Marketwatch (http://cbsmarketwatch.com), CNNfn (http://money.cnn.com/),
or Individual Investor Online (http://www.iionline.com). You can also
check the Internet or your local public library's reference shelves
for mutual fund information from Value Line or Morningstar.
Financial
magazines are another useful place to look for mutual fund information.
Magazines such as Mutual Funds, Business Week, Kiplinger's,
Worth and Money are examples of magazines that might prove
helpful.
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9. What is risk?
There
are many types of risk in investing. Generally, when you hear someone
talking about "investment risk" they're referring to market risk (or
short-term risk), which is the fluctuation in an investment's return.
Investments with wide swings in return (potential for very high gains
but also for very high losses) are said to be high-risk, while those
with more stable returns are said to be low-risk.
Additionally,
there are other types of risk you should be aware of:
- Inflation
risk. The risk that the rate of return on your investment over
time will not be high enough to offset the effect of inflation, which
eats away at the buying power of your savings. Inflation risk could
result from investing too conservatively, while market risk increases
with more aggressive investments. Generally, investments that have
a low degree of market risk also have a high degree of inflation risk,
and vice versa.
- Interest-rate
risk. The risk that interest rates will go up after you've locked
your money into a fixed-rate investment.
- Liquidity
risk. The risk that you won't be able to sell your investments
quickly for the price you want.
- Business
risk. The risk that the company or industry you've invested in
won't do well.
- Credit
risk. The risk that a borrower won't be able to repay his debt.
If
you're investing internationally, there are additional risks to consider,
such as:
- Exchange-rate
risk. The risk that when you change your money back from foreign
currency to U.S. currency, the exchange rate may have changed to your
disadvantage.
- Capital
restrictions. Since each country has its own rules on capital
flows across international borders, the availability of investments
in some countries might be restricted.
- Political
risk. The risk that a political event in the country you're invested
in will negatively affect your investment.
- Different
regulatory structures. Investors in the U.S. are relatively well
protected by a vast structure of regulations governing financial transactions,
financial reporting, accounting, disclosures, etc. In other countries,
the rules are likely to be different.
- The
unknown. Securities in the U.S. are tracked by many analysts.
For an investment outside the U.S., information might be difficult
to come by.
The
most important thing to remember is that there's no such thing as a
risk-free investment. Your goals as an investor are A) not to take more
risk than you are comfortable with and B) to make sure the returns your
investments earn are worth the risks you take.
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10. What is risk tolerance?
Risk,
in investment terms, means fluctuation in returns. Risk tolerance, therefore,
can be described as how comfortable you are with the possibility that
your investment's value will fluctuate.
Something
many novice investors fear is losing their principal. In many cases
this is an unreasonable fear. Unlike a casino bet where you can lose
your entire stake on a single draw of the cards, when you purchase a
portfolio of securities or mutual funds there's a good probability that
the companies or funds will survive almost any catastrophe and pay some
kind of return.
Knowing
how much risk you can stand is a crucial first step in developing an
asset allocation to help reach your financial goals. Identifying the
risks you face and your willingness to tolerate them will also help
you identify when your retirement portfolio faces a real threat.
Generally,
the two biggest factors affecting your risk tolerance are your temperament
(do you feel comfortable knowing that your investments may possibly
lose their value?) and investment time horizon (if you have a long time
to reach your goals, you might be able to accept more short-term fluctuation).
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11. What is asset allocation?
Asset
allocation is choosing the right mixture of different asset types --
stocks, bonds and cash investments -- to meet a financial goal.
Asset
allocation is very important; a wise asset allocation strategy will
make the difference between a legitimate investment plan and just a
bunch of investments. In fact, research has shown that the mix of investments
you choose has a substantial impact on your long-term investment returns
-- a much bigger impact than following stock tips or trying to "time
the market."
In
order to determine the best asset allocation for you, you need to figure
out three things: your financial goal, your "time horizon," and your
risk tolerance.
With
a 401(k) account, your financial goal is how much income you would like
to have in retirement.
As
for your time horizon, if you have quite a few years to go until you
retire, you might consider a strategy that focuses on maximizing the
return you will make between now and retirement. This is called a "growth"
strategy -- one in which making money over a long time horizon is your
primary concern. As you get closer to retirement, you may want to shift
to a "growth and income" strategy -- one that continues to accumulate
money for your retirement while preserving your capital.
You
also need to determine your tolerance for investment risk (i.e. how
comfortable you are with fluctuation in investment returns). You can
get an idea of your risk tolerance by asking yourself questions such
as: are you more worried that your account will decline in the short
term, or that it won't grow enough to meet your retirement goals?
At
this point, many people find it helpful to consult with an investment
or financial advisor. Based on a person's investment goal, time horizon
and tolerance for risk, it is possible to calculate the most "efficient"
allocation mix (the one that offers the best potential return for a
given level of risk).
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12. What is diversification?
Diversification
means investing in a wide variety of asset classes, security types and
industries in order to reduce risk exposure while striving for substantial
rewards. The general idea is that you want your investments to be different
enough so that when one is doing poorly, another might be doing well.
Ways
to diversify your investments include:
- Investing
in more than one asset type. For example, include stock, bond and
cash investments in your portfolio.
- Buying
different varieties of the same security type. For instance, rather
than buying just large-cap stocks, buy some small-cap, too.
- Investing
in different industries.
- Investing
in mutual funds.
- Diversifying
among different types of mutual funds.
Diversification
does more than just reduce risk. An intelligently diversified portfolio
will nearly always outperform a single investment.
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