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Americans rely heavily on the 401(k)

By Azanda L. Donaldson
Dolan Media Newswires

Rochester, N.Y. — John Steinbeck wrote that Americans still view themselves as the self-reliant, independent frontier folk who can handle themselves in any crisis with a natural inborn ability.

Crossing the prairie, traversing the Great Divide and successfully enduring the hardships on the trek west convey an appealing image of a strong and independent populace. That self image still manifests itself in a number of ways in modern life, including in the investment arena.

The strong feeling of self reliance is evident in the ways in which Americans embraced the self-directed retirement approach offered by 401(k) plans and IRA accounts over the past 30 years. Individuals were convinced that the ability to control one’s assets inevitably would result in the creation of substantial wealth and produce better results than relinquishing the accounts to an employer, or an investment adviser selected by an employer.

What is the result of individuals controlling their own destinies?

Unfortunately, it’s less than spectacular. A Watson Wyatt survey analyzed returns for years 1995 to 2007. (The survey does not include the past two years — the devastating 2008 investment year or the 2009 recovery.) The median returns for 401(k) plans at 9.06 percent were, on average, 1.07 points lower per year than defined benefit plans, which averaged returns of 10.13 percent. (The 401(k) plans are self-directed by participants while defined benefit plans typically are invested by professional money managers in a balanced mode, with equity investments representing about 60 to 70 percent of the portfolio’s assets.)

The relatively modest difference in returns becomes more significant when applied to an account balance: The 1.07-point difference in the two returns on a $1 million initial portfolio over 13 weeks equates to an additional $471,878 in plan assets in the defined benefit plan.

Even after the market recovery, some analysts are projecting that Americans have lost half a trillion dollars in the past two years. Many participants sold out of their investments in 2008 or early 2009 and directed the proceeds to money market funds. The average money market fund returned about 0.14 percent.

Worse, the participants then missed a bull market, in both stocks and bonds.

Had those participants allowed their money to be managed professionally, that would not have been the case.

The 401(k) and the IRA originally were conceived as wealth-building devices that would supplement the employer’s plan and Social Security rather than serve as the main sources of retirement income. As we trek through the wilderness of retirement planning, let us remember that our frontier forebears took along guides and scouts to see them safely to their destinations.

Azanda L. Donaldson, is a vice president at Karpus Investment Management, an investment adviser.

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