Americans show greater understanding of investment principles when selecting funds for their 401(k) retirement plans
Financial literacy appears to be increasing among Americans investing in their 401(k)s, according to Spectrem Group’s latest look at employer-sponsored retirement plans.
“Employees are allocating assets over a larger number of funds. This indicates a better understanding of the role diversity plays in reducing investment risk and maximizing gains,” said Catherine McBreen, managing director of the Chicago-area market research firm.
In the last 15 years participants in employer-sponsored retirement plans have nearly doubled the number of funds they use to invest their retirement savings. Employees used an average of 5.3 plans in 2011, up from 2.7 in 1996. Over the same time period plan sponsors have increased the number of investment options from an average of 6.3 funds in 1996 to almost 20 today.
“Obviously, between the investment education offered by plan providers and the expansion of opportunity with the increased number of funds available, the message on the importance of a diversified portfolio has gotten through,” said Gerald O’Connor, director and author of the report.
Plan participants say the primary reason they have shifted to investing in a greater number of funds is to achieve greater diversification of their portfolio. More than half describe their investment style as “moderate,” meaning they are willing to place a limited portion of their balance in investments they see as risky and are satisfied with a lower return.
Diversification divides money over asset classes, such as stocks, and among the various categories of investments that belong to that asset class, such as technology companies or companies in China, explains the Financial Industry Regulatory Authority. With its emphasis on variety, diversification allows investors to tap into the potential strengths of an array of investments, which vary in performance over time. According to FINRA, “The goal is to protect the value of your overall portfolio in case a single security or market sector takes a serious downturn and drops in price. In short, diversification spreads your risk, while still seeking a strong turn on overall investment.”
Mutual funds, such as those offered in 401(k) plans, are pooled investments that typically include a large number and variety of underlying investments, and can be a useful diversification tool, said FINRA.
“You do have to make sure, however, that even the pooled investments you own are diversified,” said FINRA. “Owning two mutual funds that invest in the same subclass of stocks won’t help you to diversify.”
Investors need to monitor their portfolio performance to make sure they are getting reasonable returns, said FINRA. The portfolio may need to be periodically rebalanced to maintain an optimal mix of investments.