September 26, 2012 / 12:31 PM / 5 years ago

COLUMN-Diversify your 401(k) in 9 easy steps

By A. Michael Lipper

Sept 26 (Reuters) - With more than 20 million workers investing in 401(k) plans for retirement, the U.S. is building one of the largest group of capital investors in the world. While similar savings vehicles are offered in numerous other countries, what's important about 401(k) plans and the equivalents for nonprofits is that they connect a large number of American individuals and their families to the securities markets as long-term participants.

Now that this population has more than $1.21 trillion in assets invested, according to the Employee Benefit Research Institute, it's time to rethink the options they have for their money.

Early in the development of 401(k), 457, and 403(b) plans there was a rush to offer every conceivable alternative in plans. The U.S. Department of Labor requires a minimum level of diversification to narrow the fiduciary risk to the employer, but this rule is usually interpreted to mean just four investment options with a combination of equity and debt funds. The Labor Department also requires a default option for employees who refuse the obligation to make choices. Yet, in some cases, companies were offering more than 200 funds.

For workers, the choices are just too numerous. Many companies these days have trimmed back to offer around 30 funds. But I go even further. When I work as a consultant with employers on the selection of options for their plans, I try to limit the number to just nine investment options.

Here's my line-up:

1. A balanced fund, which is a composite portfolio of stocks and bonds: This is my choice for a default alternative because the securities in a balanced fund are meant to be of the highest quality.

2. A high-quality, short-term fixed-income fund: Depending on the size and sophistication of the sponsor, stable value funds could be used, too.

3. A general stock market fund, which would concentrate on large high-quality stocks and is quite possibly global in scope.

4. Value-oriented funds that focus on stocks selling at a substantial discount to their perceived value: I would exclude funds that focus on "deep-value" stocks that require major changes to occur before their prices will recognize their value.

5. Small-cap funds that seek out undiscovered companies with significant potential future appreciation: Some of these opportunities may be found outside the U.S. These kinds of investments often suffer from reduced liquidity and can be very volatile.

6. A passive index that would allow participation in general market movement without the need to find managers with active selection skills.

7. A stable value fund, comprised of fixed income securities guaranteed to maintain a redemption value of a dollar.

8. And international option: Investing in securities whose primary trading markets are outside the U.S.

9. A composite product: With the right record-keeper, multiple funds in each alternative could be offered as a composite product. Also, a particularly knowledgeable adviser could deviate from these rules of thumb based on market conditions and, hopefully, in advance of dramatic changes.

One option I'd like to see, but have not yet seen anyone adopt, is for a company to offer a managed account as part of its 401(k) menu.

With these nine options the vast majority of retirement savers can find the right combination of investments to meet their long-term need to build retirement capital. However, they should not select and forget their accounts. Every time their personal financial conditions change, they should review these tax-deferred holdings along with their after-tax vehicles.

401(k)s and the like will be the largest part of the retirement capital for many Americans, and they need to be invested prudently and wisely.

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