Helping workers save in 401(k)s

If you are afraid of the stock market, you might not like where your money is headed in the company 401(k) plan.

But don’t fight it. A good dose of stocks, blended together with some bonds in mutual funds, will be good for you — especially if you are years away from retirement and won’t panic in a downturn.

And the federal government, and your employer, are working to make sure you take your medicine.

Recently, the Labor Department set in motion rules that are likely to revolutionize the way millions of Americans save for retirement. Instead of leaving people on their own to potentially blunder through the investment process with 401(k) plans, the government has laid out a preferred route. It calls for people to invest in a mixture of stocks and bonds designed to grow their money effectively based on the years remaining until they retire.

Too often people — especially young investors — think they are keeping their money safe by avoiding the stock market. About 20 percent are drawn to the safest options in their 401(k) plans — stable value or money market funds — according to Pam Hess, a 401(k) analyst with Hewitt Associates.

Although investors generally don’t lose money in these funds, they don’t make much money, either. The average stable value fund has earned 4.65 percent a year over the last five years, according to Hueler Analytics. Meanwhile, the average fund that blended a moderate mixture of stocks and bonds climbed 11.6 percent a year, according to Lipper Inc.

The difference may not seem pronounced. But over a lifetime of investing, it is. If a 35-year-old invested $5,000 a year in a 401(k) and earned 5 percent on average a year, he or she would have about $349,000 by retirement. If the person earned 7 percent on average in a conservative mixture of stock and bond funds, it would be about $505,000.

With $500,000 in savings, a person could withdraw about $20,000 the first year of retirement, following a common financial planning rule of thumb of 4 to 5 percent withdrawals so you don’t deplete your savings too soon. Then that amount would increase each year for inflation.

According to the Congressional Research Service, half of Americans within 10 years of retirement have saved no more than $88,000.

Congress tried to improve the odds that people would have enough retirement savings by passing a pension law last year that gave employers the go-ahead to become involved. The government told employers that they no longer had to wait for employees to take the initiative and sign up for the company retirement savings plan. Instead, the employers could enroll employees automatically and reroute a portion of their pay — often 2 to 3 percent — into the 401(k), 403(b) or other retirement plan.

About 36 percent of large employers are using this “automatic enrollment,” according to Hewitt.

Employers can put employees in one of three options: Balanced funds, which generally keep about 60 percent of a person’s money in stocks and 40 percent in bonds; target-date funds, which alter the mixture of stocks and bonds based on a person’s age, and so-called managed accounts. In these, a professional divides up a person’s money based on their age.

For a person in their 20s or 30s, the mixture will be heavily weighted in stocks — perhaps 80 percent of the portfolio — to help grow savings adequately. As the person ages, more money is shifted out of the stock market and moved into bonds to reduce risks. So at 65 a person might have a portfolio divided about 50/50 in stocks and bonds.

Still, Hess and others said that individuals will not be able to simply go into their future with blinders on. Most employers invest about 3 percent of a person’s pay in a 401(k) plan. And financial planners suggest 10 percent a year throughout a person’s working life is necessary.

X Gail MarksJarvis is a personal finance columnist for the Chicago Tribune. Contact her at gmarksjarvis@tribune.com.