Should I scale down my 401k?

Question

Today I met with my 401k provider at work. They tend to push certain plans and a schedule that is as follows:

1. Aggressive Fund (100% stocks, 0% bonds)
2. Moderate Fund (50% stocks, 50% bonds)
3. Conservative Fund (20% stocks, 80% bonds)

Aggressive early in career, moderate in middle of career, and Conservative at end of career.
I started asking why you wouldn't keep it in Aggressive the entire time and the whole room basically jumped on me. They say it's to protect from volatility in the market... He's the expert so I stopped asking questions.

Where is my logic flawed? I plotted the plans out as follows:

My assumptions were 7% annual growth rate, 20% standard deviation, 60 year period. Which I felt were very conservative assumptions.

Where is my mental model failing? Is it better to schedule a decrease in stock contribution?

Answer 1

Because stock markets don't always go up, sometimes they go down. Sometimes they go way down. Between 2007 and 2009 the S&P 500 lost over half its value. So if in 2007 you thought you had just enough to retire on, in 2009 you'd suddenly find you had only half of what you needed!

Of course over the next few years, many of the stocks recovered value, but if you had retired in 2008 and depended on a 401k that consisted entirely of stocks, you'd have been forced to sell a bunch of stocks near the bottom of the market to cover your retirement living expenses.

Bonds go up and down too, but usually not to the same extent as stocks, and ideally you aren't selling the bonds for your living expenses, just collecting the interest that's due you for the year. Of course, some companies and cities went bankrupt in the 2008 crisis too, and they stopped making interest payments.

Another risk is that you may be forced to retire before you were actually planning to. As you age you are at increasing risk for medical problems that may force an early retirement. Many businesses coped with the 2008 recession by laying off their older workers who were earning higher salaries. It wasn't an easy environment for older workers to find jobs in, so many folks were forced into early retirement.

Nothing is risk free, so you need to make an effort to understand what the risks are, and decide which ones you are comfortable with.

Answer 2

the whole room basically jumped on me

I really have an issue with this. Someone providing advice should offer data, and guidance. Not bully you or attack you.

You offer 3 choices. And I see intelligent answers advising you against #1. But I don't believe these are the only choices. My 401(k) has an S&P fund, a short term bond fund, and about 8 other choices including foreign, small cap, etc. I may be mistaken, but I thought regulations forced more choices.

From the 2 choices, S&P and short term bond, I can create a stock bond mix to my liking. With respect to the 2 answers here, I agree, 100% might not be wise, but 50% stock may be too little. Moving to such a conservative mix too young, and you'll see lower returns.

I like your plan to shift more conservative as you approach retirement.

Edit - in response to the disclosure of the fees -

1.18% for Aggressive, .96% for Moderate

I wrote an article 5 years back, Are you 401(k)o'ed in which I discuss the level of fees that result in my suggestion to not deposit above the match. Clearly, any fee above .90% would quickly erode the average tax benefit one might expect. I also recommend you watch a PBS Frontline episode titled The Retirement Gamble It makes the point as well as I can, if not better.

The benefit of a 401(k) aside from the match (which you should never pass up) is the ability to take advantage of the difference in your marginal tax rate at retirement vs when earned. For the typical taxpayer, this means working and taking those deposits at the 25% bracket, and in retirement, withdrawing at 15%. When you invest in a fund with a fee above 1%, you can see it will wipe out the difference over time. An investor can pay .05% for the VOO ETF, paying as much over an investing lifetime, say 50 years, as you will pay in just over 2 years.

They jumped on you? People pushing funds with these fees should be in jail, not offering financial advice.

Answer 3

IMHO your thinking is spot on. More than likely, you are years away from retirement, like 22 if you retire somewhat early. Until you get close keep it in aggressive growth. Contribute as much as you can and you probably end up with 3 million in today's dollars.

Okay so what if you were retiring in a year or two from now, and you have 3M, and have managed your debt well. You have no loans including no mortgage and an nice emergency fund. How much would you need to live? 60 or 70K year would provide roughly the equivalent of 100K salary (no social security tax, no commute, and no need to save for retirement) and you would not have a mortgage.

So what you decide to do is move 250K and move it to bonds so you have enough to live off of for the next 3.5 years or so. That is less than 10% of your nest egg. You have 3.5 years to go through some roller coaster time of the market and you can always cherry pick when to replenish the bond fund.

Having a 50% allocation for bonds is not very wise. The 80% probably good for people who have little or no savings like less than 250k and retired.

I think you are a very bright individual and have some really good money sense.

Answer 4

See if they offer a "Target Date" plan that automatically adjusts throughout your career to balance gains against preserving what you've already built up. You can adjust for more or less aggressive by selecting a plan with a later or sooner target date, respectively. (But check the administrative fees; higher fees can eat up a surprisingly large part of your growth since they're essentially subtracted from rate of return and thus get compounded.)

If they don't have that option, or charge too much for it, then yes, you may want to adjust which plan your money is in over time; you can usually "exchange" between these plans at no cost and with no tax penalty.

NOTE: The tax-advantaged 401(k) investments should be considered in the context of all your investments. This is one of the things an independent financial planner can help you with. As with other investment decisions, the best answer for you depends on your risk tolerance and your time horizon.