In 1978, what we all refer to as a 401k was born. At the time, it was a brilliant idea. Employees can set aside a certain percentage of their pre-tax income towards a retirement plan. Better yet, that retirement plan could be invested in mutual funds to help your money grow. To make it even more attractive, the employees could decide how much risk they would like to have in their portfolio, and adjust it accordingly.
In the past decade, however, we have seen these 401k’s falter. With multiple major economic downturns, as well as asset downturns, it is easy to see that the old rule of diversification no longer applies as it once did. That rule was supposed to be what prevented people from losing fifty percent or more of their retirements. Unfortunately, that is exactly what has happened to many individuals’ retirement accounts.
So why did this happen? It is fairly simple actually. If you were to break down the holdings of just one of your mutual funds, you would see that it is comprised of many many different stocks or bonds. For the sake of this example, let’s stick to stocks. Mutual funds are pigeon holed into certain areas. Some mutual funds are value oriented, others technology, biotech, large-cap growth, etc. Most mutual funds hold twenty or more stocks. What if there aren’t twenty great stocks in that sector? It doesn’t matter. Mutual funds must stay within the sector that they describe in the prospectus they send out to investors. So while there may only be five great stocks, three respectable stocks, and thirteen dogs, that mutual fund must continue to invest in that sector.
How can someone counteract this? Unfortunately, a 401k doesn’t really allow for these alterations. IRA’s, Roth IRA’s, Simple Plans, and other accounts do though. Individual stock picking has been the most efficient way to beat the S&P 500 benchmark. Mutual funds in the technology sector will hold Apple, but perhaps only a slim holding of five percent. Why in the world would anyone only hold five percent of their portfolio in Apple? Apple in just the past month is up nearly ten percent. On the year, it’s up over fiftty-four percent. Not that you want to devote an entire portfolio to one company, but a strong company, with no debt, an outstanding growth rate, and enough cash to buy Greece out of trouble deserves a little more than five percent of your portfolio.
With all of the uncertainty both in Europe and at home, value stocks remain the safest place to be. There are plenty of “value” funds out there, but how many dog stocks do they hold out of necessity? Mutual funds comprised of bonds to this day still hold sub-prime mortgages. Many value funds still hold troubled financial companies that will suffer further if Europe continues it’s descent. High growth companies that hold higher P/E ratios make up the growth centered funds that will be crushed if we don’t discover some economic stability around the world.
While 401k’s are the best option out there for employees, they have definitely become outdated. It is imperative to seek advice from a certified financial professional before making any sort of investment decisions. While hundreds of thousands of individuals lost over 50 percent of their retirement accounts, there are individual stocks out there that can still help them. Keep in mind, that if your 401k lost 50 percent, and you’re up 50 percent since 2008, that means your portfolio is still down 25 percent since the recession started. Don’t you think there are better options out there? (Note: Apple (AAPL) was less than $200 before the recession started. For illustration purposes, even if you bought it at the peak before the recession you would be up over three hundred percent.)