What You Should Know About 401(k)s

The Hook Law Center gives us a surprising insight into the financial knowledge of many people.

Just about everyone has heard the term 401(k). But does just about everyone know what the term means? No, they don’t, according to research by State Street Global Advisors (SSgA).  If they have a vague idea of what the terms means, they don’t know how to use that knowledge and actually invest. Most people find the jargon used by financial planners and other related professionals confusing. Even such words as asset allocation, equity, and fund are incomprehensible to the vast majority of people. Plain English is the key says a group of retirement plan participants whom were surveyed by SSgA. The survey was conducted jointly with the Boston Research Group in April 2012. Responses came from more than 1,000 people who actively contributed to a 401(k), 403(b), or a 457 plan. (Joyce, Hanson, “Think 401(k) Investors know what ‘Fund’ Means? Think Again,” Investment Advisor, September 2011.

Interestingly, SSgA uncovered some surprising information in their investigation. First, they found that 83% of retirement plan participants were willing to invest about 5%  of their income in a retirement plan; 64% said they would be willing to invest 10%. What stopped them? There was confusion about how to go about it. Comments such as this emerged from the study. “I don’t understand if the options available to me are really good investments, and I have no idea of what they consist of,” said one 27-year old engineer. Nor did she know what the S&P 500 was or what proportion to allocate her investments. Even young investment professionals had some questions on the matter. Brigitte Madrian, a Harvard professor at the Kennedy School of Government, reported that in a study she conducted for TIAA-CREF, even Wharton MBA students had difficulty figuring out the cost of some S&P 500 Index funds. Furthermore, Dr. Madrian reported that, “In terms of portfolio fees, investors do slightly better than if they had thrown darts in choosing their mutual funds. Very few choose the lowest fee portfolio.” (Joyce, Hanson, see above)

This goes a long way toward explaining why people either don’t begin saving for retirement until later in life, or make the wrong choices.  It’s also a great reason to get help from an RIA even before putting money into an investment plan.  Their role in your life is to teach, explain and help.

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