403B Forum – How to Make the Most of Your New Plan Menu
We’ve all heard the joke that the stock market has dropped so much in value, 403Bs are now called 203Bs. Unfortunately, it’s no laughing matter and the question on everyone’s mind is, what to do?
I’m happy to tell you that in spite of of the economic gloom and doom, there is some great news to report. Effective January 1, 2009, and for the first time in forty years, there are new mandated regulations and reforms that will both greatly expand your investment choices and allow you the flexibility to customize your portfolio with an enticing range of asset allocations.
For years, investors were screaming that the market was broadening and all they got to pick from were vanilla, chocolate and strawberry. Now, investors will have an almost unlimited menu of options, like walking into Baskin-Robbins. Choices will include international funds, treasury funds, government funds, asset allocation funds, funds that are pre-mixed for a conservative investor vs. a higher-risk investor and already target funds, which are designed for those who have a retirement timeline. For example, the fund
may be set up to have an expiration date of 2010, or 2015 and will be built to maximize the remaining years of deposits.
Of course, the possible down side of having so many new choices is that it can easily be confusing. How do you know which investments make the most sense for you? Should decisions nevertheless be based on age and/or years until retirement? And what about risk tolerance? With the market being so volatile, should already first-time investors be more conservative?
These are all excellent questions, and here is what we have learned since the unheard of volatility has made everyone rethink their strategies.
The old rule of thumb was that the closer you were to retirement, the more diversified and conservative your investment strategy needed to be. Those who were just starting out in their careers could have a higher risk tolerance because they had time on their side. But now, already new investors are saying that they don’t have the stomachs for a roller coaster ride. Like their parents, they are more concerned about the return of their money instead of the return on their money.
The other old rule of thumb was all about diversification and asset allocation, but there again, those terms are being redefined because of the huge market swings. In the past year, we’ve seen extensive evidence that portfolios that were thought to be different enough were truly not because of the way certain asset classes behaved.
The first eye opener was the realization that both stocks and bonds were weakening simultaneously. Historically, there was an established inverse or see-saw effect. If stocks went up, bonds went down. The same was true of U.S. equities and foreign stock funds. If you had both, you considered this true diversification because they didn’t move in tandem and offered true protection. If one was the soft, the other would be more strong.
What changed the playing field was the globalized economy. Today there are so many multinational companies, U.S. companies selling overseas, foreign companies exporting to the U.S., etc. when the market dropped, they fell together. Gone was the concept of diversification.
In light of this, not only do investors needs to feel a certain comfort level with their choices, they now need to understand how asset allocations and volatility impact their portfolios. Truly there has never been a more important time to make strategic choices. Fortunately, there are some great tools to help you compare the ever-increasing options you have, and at the same time, measure volatility.
To that end, the new buzz information is asset class correlation or basically a risk rating. A correlation index indicates how a specific investment category is faring in terms of volatility when compared to other categories. Every fund that is obtainable for your 403B will come with a prospectus which reports on risk and correlation (Be sure to review these reports along with your plan administrator or financial advisor).
for example, historically, large cap stocks and the foreign stocks were always believed to perform differently, but the reports now show that over the past ten years, 90% of the time they behaved the same way. Conversely, real estate funds behaved very differently than large cap stocks more than 80% of the time, so going forward, that would offer much more diversification.
clearly by choosing a mix of stocks, bonds, real estate and fixed accounts for your 403B, you can better control the risk and the correlation. This method that you will have truer diversification and the ability to resist volatile periods because some asset classes will be up when others are down.
Rocky Road is great when you’re choosing ice cream, not so much when you’re trying to manage your portfolio.
What I Know That You Need To
Q. How can I find out more information about what is inside my mutual funds and what the volatility and correlation index might be for each one?
A. Investors can go online and use many investment tools such as morningstar, Thompson Financial, Value Line and of course, for in thoroughness examination, you should always check out the website for the mutual fund companies you own.
Q. How can I find out which funds have been approved for my 403B?
A. Each school district has a plan administrator or business office that coordinates the 403B plan with a third party administrator, who then prepares the documents and the approved plan selections. Check with them to determine what your choices will be after the January 1 mandate.
Q. If I’m new to teaching and am just starting to invest in a 403B, what should I be doing differently than a teacher who is nearing retirement?
A. Great question. The best decision you can make when you’re first starting out is a function of budgeting. Too often, teachers feel that because their salary is smaller than those who have been in the field for a long time, that they can’t provide to earmark their salary for savings. They’ll wait until they earn more. The trouble with that thinking is that it takes away the one thing they have in their favor- time. If you put away already 5% to 10% of your salary from the beginning, that money will have twenty to thirty years to compound. And given the low stock prices now, by buying in when bargains abound, this could be extremely meaningful years down the road. Then in a few years when your salary is higher, it would be ideal to increase to the maximum deposits of 20%, allowing for further growth and compounding. Remember too, that one of the other big advantages of investing in your 403B is that it is tax deductible, thereby reducing your tax burden.