by Archie M. Richards, Jr., CFP^®
March 4, 2002

Enron brought home a serious problem with 401(k) plans. While we're at it, there are two additional problems to watch out for.

Eighteen months ago, Enron employees expected the stock to fly ever higher. They invested 63 percent of their retirement money in Enron stock. With the company's failure, $1 billion of their savings was lost.

Take this to heart. No matter how sparkling the business prospects of your employer, minimize your investment in the company's stock. Your current income depends on the employer's success. If that fails, you're out of a job. This alone is sufficient risk.

But loading up your retirement plan with your employer's stock piles on additional risk. If the company falters, not only are you out of a job, your retirement income is jeopardized.

To the extent you can, invest your retirement money elsewhere. A pillar of successful investing is diversification. Enron employees learned this too late.

Here's the second potential 401(k) problem:

The expenses of many 401(k) plans are too high. Attorney Brooks Hamilton, a Dallas, Texas retirement plan consultant, points out that the annual operating costs of many plans have climbed to 3 percent or more. The costs are generally hidden from employees.

Over the long pull, higher expenses that seem insignificant actually cut retirement income tremendously. Here's an illustration:

John and Joe work for different companies, but they otherwise have many similarities. They're both 35 years old. They both earn $35,000, and their pay increases by 4 percent a year.

Each of them invests 6 percent of pay into his 401(k) plan. The employers match 50 percent, causing retirement plan contributions to total 9 percent of pay (6 + 3 percent).

Before costs, the investments in both plans earn 10 percent a year.

John and Joe retire at age 65. During retirement, they and their spouses survive for 23 years. The income payments they receive remain constant from one month to the next. The plan values reach zero at their deaths.

Now for the difference between the two plans: The annual expenses of John's 401(k) amount to 1 percent. Joe's plan costs 3 percent per year.

After expenses, John's plan therefore gains at 9 percent per year (10-1 percent). Joe's net annual return is only 7 percent (10-3 percent).

Here are the results: During retirement, John and his spouse receive income payouts totaling $1,656,748. Joe and his spouse receive only $1,009,420. Their retirement income is reduced by 39 percent - a whopping $647,328!

The $647,328 goes to the financial companies, not to Joe.

A cost difference of only 2 percentage points doesn't seem like much. But the reduction of Joe's retirement income is enormous. In some cases, salesman commissions add on to the 3-percent annual costs, making the results all the more detrimental.

If you're participating in a 401(k) plan, investigate the total costs as best you can. Read the plan documents, check the prospectuses, and make inquiries with the plan administrator. If the costs exceed, say, 1.25 percent a year, let your employer know your thoughts on the matter. You have no direct control over the costs, I realize. But if they're exorbitant, you can at least minimize your participation in the 401(k) plan and invest elsewhere.

Now for the third potential problem:

Unless you select investments for your 401(k) account, the money probably goes into a money market fund, earning a pittance.

If you haven't selected your investments, you probably reason that you're no investment expert. You figure the stock market jumps around too much; better to stay out.

Believe me, this is a mistake. You don't have to be an investment expert. Put some of your retirement money into mutual funds that invest in the largest number of stocks. Big, small, domestic, foreign - gain exposure to as many different types as you can.

Forget the market's short-term fluctuations. Every day, the people of the world are creating wealth. In the long term, this brings growth to a broad-based stock portfolio. You need only tag along for the ride.

The three problems with 401(k) plans come down to this: Cut costs and diversify.