It's hard not to feel despondent about your dwindling 401K these days. Gazing on that crushingly puny number on your statement each month can snap you right out of your post-election afterglow and start you on a miserable chant: No, I can't.
And hearing your parents and neighbors carp about their diminished means doesn't help -- they have guaranteed pensions to rely on, after all, something that may be all but obsolete by the time those of us in our 20s, 30s and 40s even think about retiring.
So is there any hope to be found on the retirement front? Is there anything you can do to right your listing 401K ship and steer happily toward that blissful retirement horizon? Like so many others, I was curious. And also like so many others, I don't really understand half of what I've ever been told about 401Ks -- named, unsexily enough, after a section in the Internal Revenue Code that allows employees to save for retirement by having money taken directly out of their paychecks (before they're taxed on it) and invested in some combination of mutual funds including stocks, bonds or money market funds, as they instruct. I also wondered how to adjust my retirement-planning behavior in response to a plunging stock market, widespread layoffs and even wider-spread declarations of doom.
So David Wray seemed like a good man to talk to. Wray is the president of the Profit Sharing/401k Council of America and author of the book "Take Control With Your 401(k): An Employee's Guide to Maximizing Your Investments." He also happens to be about as upbeat about your chances for a decent retirement someday as a person can be in these economically troubled times.
Sure, things are looking financially bleak and no one knows what further misfortune awaits in the coming year, but, Wray predicts, long-term, America will take two steps forward for every step it has taken back -- and if you plan carefully and play things right, you can see your shriveled retirement account recover, even soar. Yes, Wray says, you might actually come out of this dark time in better financial shape than ever.
The question, of course, is "how"? So I asked Wray to explain in the simplest terms possible why we should all keep chucking our hard-earned money into our 401Ks only to watch it get sucked away, exactly how to "balance" our "portfolios," as everyone instructs us to do, and whether we should just give it all up and surrender to the notion of a destitute old age. Speaking on the phone from his office in Chicago, he patiently did his best to talk to me about retirement like I'm 5 -- a 5-year-old who happens to have a house, a husband, two children and decades to work until retirement, that is.
As someone of modest, solidly middle-class means, who's been putting some portion of my paycheck into my company 401K, which is not matched, I should be panicking right about now, right?
No, you should not be panicking. There is an underlying assumption to saving and investing, and that is that America will continue to be a successful place. That's a fundamental assumption.
But is that a bad assumption?
That's a good assumption. We have over 200 years of experience here. America has the most productive economy -- and the most entrepreneurial, innovative workforce -- in the world. We have tremendous natural resources. So it's a certainty that America will continue to be a very successful place to be, economically.
That's not just patriotic rah-rah? I mean, we made some pretty bad mistakes.
People can make mistakes, and they do. That's why it's not a straight line to the stars. We have cycles of growth and retreat. That is historic. But if you look over time, our country continues to move upward. So am I confident? Absolutely.
But I can't even look at my 401K. I'm sure it's gone way down. And here I am, putting more money into it.
Well, as a young person, you shouldn't look at the values, because the values are not relevant. Let's say you're 40 years old -- I'm 61, so 40 is young to me -- and you have $40,000 in your plan.
Is that a shameful amount?
No, absolutely not. Remember, the goal here is to have money when you retire. Something is better than nothing. So, OK, let's say on Dec. 31, you had $40,000. And that money was invested 70 percent in equities and 30 percent in some kind of fixed investment.
What's a "fixed investment"?
It would be bond funds, money market funds, stable value funds.
So 70 percent in stocks and 30 percent in some version of those?
Right. So what's happened is the value of your equities is down -- let's say it's down 40 percent. So that 70 percent, that $28,000 is now worth -- well, we need a calculator. [Quiet tapping] It's now worth $16,800. The rest of the portfolio is plugging along, giving you a pretty crummy return: 2 percent. So the other part of your portfolio, the $12,000, is worth [an additional] $240. So what you've got in your 401K, total, is ... $29,040.
Down from $40,000 a few months ago? That's pretty cruddy.
That's not good. But you're not selling. You haven't lost anything, because you're not selling anything. Now, for the last nine months, you've been putting money in the plan.
That's true, and the market is nice and low.
Right, so the same amount of money buys you more stocks. Let's say your salary is $40,000. The typical 401K participant is putting in 10 percent of their salary, between them and their employer. So $4,000 a year is going in. So we put in three-quarters of that. So $3,000 is now in the plan, and $2,000 is buying those very low equities. And $1,000 is going into your fixed account, which is giving you another 20 bucks. So what you've done is, the basis on your equity has come down a little.
What does that mean?
The basis is the amount of money you paid for your equities. So you're bringing down the average cost of the stocks. So what happens is when the market goes back up, your portfolio will go up faster than it went down. And certainly if the market gets back to where it was, you're ahead, because you've been buying low.
So I should be putting even more money in my 401K right now.
That's correct. If you are a long-term investor, and you are. The target age for retirement is 67 years old. And for our hypothetical 40-year-old, Social Security is going to give them 100 percent of their benefit when they're 67 years old. That's the rule.
Is that true? Can we depend on that really?
My own view is absolutely. I believe that the benefits promised in Social Security for nearly everyone will be met. There may be some modest adjustment. But the benefits will be there. When you're 67, you're going to get something.
How much will our hypothetical 40-year-old be able to count on, do you think?
It depends on their final income. The median wage worker who retires at the opportunity to get the full Social Security benefit is probably getting around 35 to 40 percent of final pay. You can go onto the Social Security Web site. They have a calculator. It gives you various ways to model what you would get. So you could put our 40-year-old making $40,000, and it will tell you what this person will get when they're 67.
OK, let's talk about allocations, where and how I invest the money in my 401K. What should I be doing now? I have my 401K, I'm putting money into it. You say it's OK if I just put it in the file each month when it comes in the mail and pretend it isn't there. But that's assuming I made good choices about allocations in the first place, right?
Whatever you did, you're going to have more than you would have if you had done nothing.
But let's say I took the standard advice and chose a balanced portfolio, but then after making my initial allocations, I never touched them again. That's fine, you say?
That's bad. What you should do is sit down and do a long-term financial plan.
Who does that?
Well, no one does it, probably, but I thought you wanted a "best-case" scenario.
And, believe me, when people get to be about 50, they start thinking about this. When people get over 40, and certainly over 45, they start thinking about retirement.
Oh my god! I guess I'll have to adjust my thinking.
You have to start thinking about the future. Think about this: You're going to live to be 100 years old. Have you thought about that at all?
No.
Well, you might want to start thinking about that. When people get older and approach retirement, they start thinking, "Oh, I'm not going to be working for the rest of my life. Well, I better have some savings," and they start saving for retirement. And the earlier you have that thinking process the better off you are. Because then you can start to put in place a plan that will help you accomplish whatever you think you need to accomplish.
And when you make your asset allocation, you need to rebalance every year. You need to go back and put your percentages back in order.
How do I know how to rebalance? I didn't know how to balance the first time.
Well, companies give you materials. There are modeling programs. And more and more companies are giving the opportunity for participants to say, "I don't want to do this. Do it for me." It's called lifestyle funds and --
I wish more companies did that. The 529 college savings fund I started for my son automatically allocates and adjusts based on his age and when it's estimated he'll attend college, and the return on that is much better than my piddly little attempt at 401K allocation. But many of us have no idea how to allocate. We feel good if we're just putting money into it. We feel like if we're putting money in, it will take care of itself. But that's pretty dumb, right?
You want to make an informed decision. Fortunately, there has been a recognition over the last five years that many workers would rather have somebody else do this for them. And so more and more companies are doing this. It should be fairly universal within a short period of time.
So pretty soon 401Ks will be idiot-proof?
Well, I don't know that it will be idiot-proof, but the company will say, "Look, you don't have to do this. It's your money. But if you don't want to do anything, check this box. We'll take care of it for you."
What portion of my paycheck should I be putting away for retirement, given the fact that I also have a mortgage and day-to-day living expenses, and I need to be saving money for college for my kids?
We want to recognize that people have to live for the moment, too. But people really, really ought to try to get 10 percent in their plans, as kind of a floor.
How should we educate ourselves about how to allocate our 401K money right now?
Well, the good news is that what's happened over the last year and the last few months especially has caused the 401K community to make even more information available to participants if they want it. The providers who support 401K are hiring more people to be on the other end of phone lines. So people should check their plan. There's probably an 800 number you can call if you want to talk to someone. It's never been easier to talk to them. There's a tremendous amount of information.
Well, that's the problem. There's either not enough information or there's too much information.
Well, more companies are providing people who can give you advice. A lot of the sites have online advice. If you want to spend a half an hour loading in financial data and things about your plan, it will give you a recommendation. It will say, "Here's your situation," and it will suggest, "Here's what you should do." And often you can call to get advice. Back in 1993, the companies didn't give advice. Now more and more companies are providing those services.
I've heard a lot of companies are starting to take away their 401K matching. What's going on? Is this the end of the 401K match? Are we all on our own now?
Well, there are two kinds of matches. There are matches that are fixed, that are part of the plan, and then there are variable matches. Companies that have fixed matches, for those to be suspended is very unusual -- G.M., for instance [which announced in October that it would suspend its matching program]. At a lot of the companies, the match is discretionary, which means that the company makes the match if it can. Now usually the company makes the match. It's in the best interests of everybody if there's a match. People contribute more. They're better off. The point of the whole system is to build loyalty from your workforce. Taking away the match is not a way that you make your workforce happy.
Remember, companies compete for workers and its 401K is one way that they do that.
Right, but if there's widespread unemployment and workers are a dime a dozen and companies have to cut something, then what's the motive for keeping it?
I don't know. All I can say is that historically the overall matching rate declines when things are slow. And they're higher when things are good. But companies by and large continue some kind of contribution into the plan. It is important that your current people showing up to work are committed, that they show up to work ready to go, and this is one of the ways that you help that happen and you can keep your good workers. It may be slow finding jobs, but there are jobs out there. Even in the worst of times, there are people getting new employment.
So you don't think matching is going to go away.
No, it's not going to go away. In 2001-2002 we went through a very bad period. People forget. I mean, in 2001 the economy stopped for a month. So we had a similar pattern back then. A few people, not many, suspended their fixed match. Some others who had these variable amounts reduced them because the companies were financially challenged. And then when things got better, the matches were brought back or the discretionary matches went back to their higher levels. But remember, this is a company-by-company decision. Even in the worst of times there are going to be companies that are doing very well. Because bad times for some are good times for others.
Do I have to worry about the company holding my 401K going bust?
No. Whatever it's worth, it's in there, it's yours. You don't have to worry about that.
So should I behave differently with an unmatched 401K than I would with a matched 401K?
If you've done your master plan and you know where you want to be, if the company is not contributing, you have to recognize that you either make up that difference yourself of you accept there will be less at the end of the day.
We're back to the master plan?
Frankly, people should even just do a personal one-year budget. That's a good start.
You sit down and you figure out, OK, what is the future? How long do I want to work? Have I talked about this with my spouse? You and your spouse should be having this conversation so you're on the same wavelength.
OK, so tell me what we need to consider.
Well, you need to look at your family's health history. You need to look at your own personal health history. Health is critical. But as you plan for your future, it's even more important because the variation in health experience is enormous. Some people are going strong, and they're 93 years old. And some people can't pick up a telephone, and they're 63. You should look at your current assets. Your current jobs. How much you're making. How much of your money you're currently saving. You need to do an inventory of where you stand, what your current assets are, and you need to look at where you are going to be in 15 or 20 years.
So how much do I need to retire, how much do I need to have saved?
I don't really think there's a single target.
But then I don't really know what I'm aiming for, exactly.
I can give you a rule of thumb that will guarantee a retirement where you basically can continue to spend like you were before.
That sounds good. Go ahead, scare me. I'm ready.
I'm going to scare you. We've done a lot of studies: Ten times final pay. So if your final pay is $50,000, you should have $500,000 in a 401K plan [when you retire].
OK, I may not ever get there, but that's actually lower than I thought it would be. So our 40-year-old with the $40,000 salary and the $40,000 in their 401K, are they on track for that?
We can see where they are. So our hypothetical person is contributing 10 percent of pay, and they're in a diversified portfolio. Making certain assumptions -- that they get salary increases, not huge ones, but just a steady middle-of the road increase -- they'll be making $88,852 a year when they retire at age 67. So their goal is to have $888,520 saved. And with their current rate of pay, their total savings will be $817,772. So they're $70,748 short.
That's not so bad.
That is not bad. 401K is about getting rich slowly. The power of compounding is enormous. Now what if you don't make any contributions? Let's change the formula.
Let's say this hypothetical person loses their job. They have their $40,000 in their 401K, and they just let it run. They roll it into an IRA and don't do anything else. They'll still have $319,522 by the time they retire. They're almost halfway to their goal because of the $40,000 that they already have.
And even with the economic downturn, you're optimistic that we'll continue on track.
Yes, with an understanding that, as you get closer to your retirement, you'll cut down on your investments in stocks. You're going to increase the fixed investments and cut down the volatile ones. Because you don't want to be ready to cash in your $800,000, and because the market did what it did the last three months, it's suddenly $600,000.
So a few years before I retire, I start to shift my investments, little by little.
Yes, and those target funds that we were talking about, the companies do that automatically for you, when you get closer to when you need the money. On the other hand, you need to look at your own situation. Because maybe you're like my dad, who took his final paycheck when he was 85 years old.
Wow.
So some people keep going. Some people want to retire when they're 58.
Aren't there huge consequences for that at this point? Can anyone retire that early anymore?
If you have enough money. It depends on your circumstances. There are people who are extremely thrifty. We don't really see them much.
I try to save and make careful choices, but I don't know if I'll ever be in a position financially to retire.
That's why doing a plan and some calculation will help. Right now, part of what's driving all the fear is the uncertainty. And I think if people would sit down and figure it out, they'd feel better.
Yeah, well, sure, if everyone had someone to figure out the calculation they'd feel better, and you're saying companies are starting to do that -- because there's been a recognition of the workers' overwhelming cluelessness.
Also the recognition that the need for help is universal. And the companies have responded. In 2000, 2002, the cold water got thrown on us. We've seen an explosion of support for 401K participants in the last five years. Automatic enrollment, automatic rebalancing, the increase in advice.
So is it more likely or less likely that we'll end up destitute?
What we have to look at is that currently, people who are retiring today are retiring in good shape. I don't see why future generations shouldn't continue to do very well in retirement. I think we all have to recognize that we're all going to live to be 100 years old. That's the good news. The bad news is, we're going to have to take care of ourselves in this period. But the balance sheets of everyone in America are going to be stronger when we get out of this.
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