Saturday, January 21, 2006

Fixing my 401k

I started my 401k around 1999, but I only started paying attention to it in 2001, when I changed jobs and began funding it in a more serious way.

I had gotten the 401k mantra that everyone repeats through my head -- "max your employer match" -- but no one had ever offered me any advice about the next step (and I hadn't sought any out): picking from among the large assortment of mutual-fund options. My employer sent along a thick folder of prospectuses and a power-point deck about "401k strategies." I flipped helplessly through these papers a few times and came away only with a vague impression that as someone with more than 30 years to go till this mythical "retirement" phase, I could afford to try out a few of those investment options labeled "aggressive." I picked out 10 funds in various categories, spread my money somewhat randomly across them (20% or so to a bond fund for safety; 4% to a "technology" fund because hey, I'm a tech reporter, and I should support the home team), and forgot about my 401k.

Every year or so I would notice the pile of statements ING mailed me and open one to see how my 401k was doing. Each time, I'd be astonished by two things: 1) it had actual money in it, in sums that felt rather sizable to me. Yay automatic paycheck deductions and investments!, and 2) the "investment earnings" section was usually negative. Now, this was all post-bubble, and the stock market was doing nasty things to most people. I was never tempted to stop funding my 401k because my employer match kept me coming out ahead, and I knew that if money wasn't being automatically deducted, I'd waste it anyway. But it gnawed away at me, and I finally hit the point last Spring where I decided to do some research and try to staunch the red ink.

After only a few hours of research, I'd reached a startling conclusion (well, startling to one who earns a living as a business journalist): I hate money. I hate finance. Stocks and Wall Street strategy bore the hell out of me. Not just interminable, predictable-bad-movie boredom; this was 'I would rather jab my eyes out with flaming Q-tips than keep reading this stuff' antipathy.

So I gave up on research and went for Plan B. I asked older, presumably fiscally wiser friends for advice on 401k distribution. One suggested that I check out the "Couch Potato" strategy.

Some Googling explained the method to me. It's a formula cooked up in the early '90s by Dallas Morning News personal-finance columnist Scott Burns. Its core tenant: Most mutual funds charge management fees. However, most mutual funds don't outperform indices like the S&P 500 over the long haul. Therefore, you can do reasonably well passively investing in just a few basic index funds and otherwise taking a hands-off approach with your 401k.

The fees issue is something I hadn't thought about at all, but which turns out to make a huge difference for long-term investing. Mutual funds charge management fees (.25% to 2% seems to be roughly the range) which come not off your profit, but off your total invested assets. So, say your $1,000 investment is in a fund returning 10 percent growth for the year. Now you have $1,100. If you lose half a percent of that to the management fee, you deduct $5.50, and your total gain for the year is $94.50. With a 2% fee, the management cut jumps to $22, and your gains are down to $78. Pretty big difference -- especially when you start calculating it for hundreds of thousands of dollars.

Because there are no high-priced judgement calls involved in running index funds (which simply buy the stocks included in the indices), they have low management fees. The Couch Potato ethos is to put half your 401k assets in an S&P 500 Index fund and half in a bond market index fund. I opted for one of Burns's more recent passive-investing concoctions: the Margarita Mix. It's slightly more aggressive, and calls for a three-way mix of a domestic stock index, an international stock index and an inflation-protected Treasury securities fund.

So how'd I do? Consistently positive returns since I made the switch in April, and a 12% return for the trailing twelve months, according to my December statement. OK, what really matters is how this performs over decades, not six months, but still -- it's comforting to finally see my 401k investment returns go up, not down.