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Playing it Safe Can Hurt Returns - WSJ

September 12, 2009

By ANNE TERGESEN - WSJ Sep. 12, 2009

Investors in 401(k)s are reacting to down days in the stock market by plowing money into conservative investments, such as stable-value funds, recent data show.

But a new study suggests that for those nearing retirement, there's a big price to be paid for abandoning a diversified portfolio of stocks and bonds.

In 2008, as stocks lost nearly 40% of their value, participants in tax-deferred 401(k) retirement savings plans that are administered by Hewitt Associates sold $6.3 billion in equity investments, according to the Lincolnshire, Ill.-based human-resources firm.

These investors put the vast majority of the proceeds -- some 85% -- into conservative investments, "mainly stable value funds," which are designed to preserve capital and generate smooth, positive returns, says Pamela Hess, Hewitt's director of retirement research.

The transfers, which have continued this year at a lower level, have helped reduce the average equity exposure in 401(k) plans to about 53% in June, down from 67% at the end of 2007, according to Hewitt.

But those "who impulsively transfer assets to more conservative funds during market slumps may hurt their ability to save enough for retirement," Ms. Hess says. Hewitt has found that most investors who flee equities "are unlikely to reallocate their investments [to stocks] when the market rebounds," she adds.

Hard to Catch Up

A study by Financial Engines, a Palo Alto, Calif., investment advisory firm, looks at how self-defeating such a strategy is likely to be. The study examined the effect of the 2008 stock-market selloff on investors age 50 and older who consistently save about 9% of their salaries annually.

It found that those who remain in suitably diversified portfolios can, under most scenarios, expect to retire with 70% of their current income by taking some relatively simple steps -- such as postponing retirement by up to 2½ years, or less if they're willing to ramp up savings.

But those who fled to cash-like investments will generally need to take more drastic steps, such as postponing retirement by an additional year or more, depending on factors such as age and income, Financial Engines calculates.

Consider a 60-year-old who has an annual salary of $75,000. By remaining in a diversified portfolio, with about 50% in stocks, he or she can expect to get back in shape financially by putting retirement on hold for almost two years -- from age 65 to nearly age 67, according to Financial Engines. After a move to cash, though, he or she would have to stay on the job a year longer. Financial Engines simulated thousands of different potential market returns and calculated the median outcome.

More to Lose

As a rule of thumb, the cost of fleeing to cash rises with an investor's income. Because those with more wealth depend more on savings than on Social Security benefits to maintain their living standards in retirement, they have more to lose by loading up on low-return investments, says Wei-Yin Hu, director of investment analysis and research at Financial Engines.

Likewise, younger investors who abandon stocks are likely to pay a higher price than their older counterparts. Why? They are giving up more in the way of potential future appreciation, Mr. Hu says.

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