Investors’ Safe Strategy Had Its Own Costly ‘Risks’

To understand why Dona Mastin is so conservative with her investments, you have to go back more than 20 years, to her first foray into the stock market.

In the late 1970s, Mastin and her husband, Wayne, began buying shares of the trucking company where he worked. For a while, things went great. The couple’s modest investment in the stock more than tripled, reaching $27 a share.

Unfortunately, the Mastins did not know when to sell. The stock reversed, and they rode it all the way down to $7 before they finally bailed out.

It was a bitter experience, Mastin says, so much so that when she started to invest in a tax-deferred 401(k) retirement account in 1984, she decided to play it safe.

Too safe.

While many of her co-workers were shoveling their 401(k) money into the Fidelity Magellan stock fund, which was then being run by the legendary Peter Lynch, Mastin, who was still in her 20s at the time, put most of her retirement funds in ultra-conservative money-market (cash) and short-term bond mutual funds.

As a result, she missed out on Magellan’s 28.5% average annual returns throughout the 1980s.

“I blew it,” says Mastin, now 43. “I was a total idiot.”

Today the West Covina area resident works for a different company, GTE, and contributes to a different 401(k) plan. But she still clings to a largely conservative investment strategy.

“I know I’m being way too conservative,” she says, but she isn’t sure how to change her investment program to get more aggressive--or how aggressive she should be, especially inside her 401(k) plan.

It’s an issue for many investors who have played it relatively safe in recent years, while the stock market has rocketed.

At first glance, Mastin’s 401(k) mix actually looks fairly aggressive.

Nearly $2,500 of the $15,000 in her 401(k) account is invested in a Fidelity-run “commingled trust” that tracks the benchmark Standard & Poor’s 500 index of blue-chip stocks. A commingled pool or trust is like a private label mutual fund and typically charges low fees.

Another $1,300 is invested in Fidelity Magellan, which Mastin finally mustered the courage to buy.

And $5,400 of the 401(k) balance is invested in GTE stock, part of which has accumulated because GTE matches employees’ 401(k) contributions in GTE shares.

Still, about a third of Mastin’s 401(k) is invested in three “pre-bundled” investment options that are invested mostly in bonds and cash.

These pre-bundled investment options (in some plans, they may be called “lifestyle” funds) are found in about one in five 401(k) plans nationwide and are often used by novice investors because they invest in a preset mix of stocks, bonds and cash.

The problem for Mastin is that the “conservative” pre-bundled fund she chose, which by itself accounts for nearly 20% of her 401(k), is all bonds, or “fixed-income” investments. She also invests in the “conservative growth” fund, which is 75% fixed income.

Even her “moderate growth” fund is 50% bonds, with the remainder invested in a combination of five stock funds that invest primarily in large U.S. stocks, which Mastin already has exposure to through her S&P; 500 fund and Magellan.

To be sure, it’s not unreasonable for investors in their 40s to want to have some portion of their retirement assets in bonds or cash to stabilize their overall portfolio and to preserve the gains they’ve already earned.

But for Mastin, this bond weighting is too much--especially in light of the fact that so much of her non-401(k) assets are already invested in bonds and cash, said West Los Angeles financial planner Joel Framson, who reviewed Mastin’s 401(k) allocation for The Times.

“People forget there’s a risk in being too conservative: the risk of running out of money in retirement,” Framson notes. Bonds simply can’t provide the growth that stocks can over the long term.

Outside her 401(k), Mastin has roughly $25,000 in a fixed-income annuity contract, which she accumulated by rolling over her previous employer’s 401(k).

In a separate IRA, Mastin has nearly $8,000 invested in bank certificates of deposit. In addition, husband Wayne has nearly $7,000 in an IRA that is also invested in a CD. And jointly, the couple have about $21,000 in after-tax savings accounts and money-market funds.

So although most of her 401(k) money is invested in stocks, if you were to look at all her accounts together you would see that her equity allocation is quite low--18%--for someone her age, especially for someone without children or consumer debt to worry about.

Framson also reminds Mastin that Wayne, 47, a Teamsters union truck driver, is eligible for a $28,800 annual pension should he retire early at age 53. If he continues working until he’s 65, he would draw a pension of $53,557 a year.

That money should be considered a fixed-income investment for the purposes of asset allocation. And that should give Mastin even more flexibility to invest in stocks inside her 401(k).

Overall, Framson thinks Mastin should have about 80% of her total portfolio in stocks. Specifically, he recommends the following asset allocation mix:

* 25% in U.S. large-stock funds.

* 20% in large growth-oriented and/or technology stock funds.

* 20% in international stock funds.

* 15% in U.S. small-stock funds.

* 20% in short-term bond funds.

Given that Mastin’s 401(k) makes up less than 20% of the couple’s total portfolio, she’s not going to be able to get more aggressive, and raise her long-term returns, simply by making adjustments in the 401(k) plan. She’ll have to make changes to her outside accounts, too.

But Framson suggests Mastin first put $12,000 in a money-market account and not count that as part of her overall portfolio. Everybody needs an emergency fund, he says, and the couple are in the process of buying a new house, which will increase their mortgage payments and incidental costs.

With the remaining $67,300 in her investable portfolio, Mastin can start making some adjustments.

In her 401(k), Framson suggests the following:

* Take money out of the pre-bundled funds. For one thing, Mastin was using them in the wrong way.

Each of the pre-bundled funds is designed for people of a particular age or risk-tolerance. For instance, the “conservative” option is really designed for those close to retirement who want to preserve their assets. “Aggressive growth” is designed for investors with 20 years or more to grow their money. But Mastin has small amounts invested in each of the five pre-bundled funds, which defeats their purpose.

Also, says Framson, she can control her asset mix more easily by investing directly in individual mutual funds offered in her 401(k). “It’s like the difference between building a tract house or designing and customizing your own dream house.”

* Reduce company stock. With more than half of her equity investments in GTE stock, Mastin would do well to remember what happened to that long-ago investment in the trucking company stock.

Financial planners often suggest holding no more than 10% of your overall portfolio in your company’s stock. After all, your salary and benefits are already dependent on the company; you don’t want too many eggs in that same basket.

Also, because her company matches her 401(k) contributions in the form of GTE stock, there’s little reason for her to buy more, Framson points out.

(The stock will eventually become Bell Atlantic shares, because the latter is in the process of acquiring GTE.)

In Mastin’s 401(k), she is not allowed to sell the GTE stock she receives in the form of matches, but she can shift out of the GTE stock that she bought through her own 401(k) contributions.

* Take money out of Fidelity Magellan. This may sound strange, given that Framson wants Mastin to increase her equity stake. But he argues that she doesn’t need to own Magellan because she already owns the S&P; 500 index fund.

Fidelity Magellan “is very much like the S&P; 500 fund,” Framson says.

Indeed, Magellan and the S&P; 500 have posted nearly identical gains over the last one, three, five and 10 years. “Plus, Magellan’s expenses are higher and there’s not been a lot of consistency of style with the fund,” Framson argues.

* Consider shifting a large sum into the S&P; 500 fund. Framson believes Mastin should move all available 401(k) money (excluding the GTE shares she can’t sell) into the S&P; 500 fund and make that her U.S. large-stock allocation. “My approach is to pick the best of the funds available in the 401(k) plan first,” says Framson.

While there are a fair number of decent investments to choose from in Mastin’s 401(k), “there are better choices in various categories outside her plan,” Framson argues--except for the plan’s S&P; 500 index fund, which charges even less in annual expenses than the low-cost leader, the Vanguard 500 Index fund.

This approach also makes sense because Mastin has the flexibility to make new investments outside her 401(k). For example, she can cash in her fixed-income annuity without penalty as of March 18.

If she didn’t have flexibility to invest money outside the 401(k), Framson’s next suggestion among Mastin’s 401(k) plan options would be MSDW Institutional Equity Growth. This would help satisfy her need for growth-oriented or technology stock funds, Framson says, because it is more growth-oriented than Magellan or the S&P; 500.

If Mastin wants to invest in a foreign fund inside her 401(k), Framson favors Templeton Institutional Foreign Equity Fund over Fidelity Overseas, to which Mastin began making small contributions recently. The Templeton fund, being institutional, has considerably lower management expenses than Fidelity Overseas. Plus, it invests more outside of Europe and Japan.

In fact, Framson suggests that, after reallocating her existing 401(k) assets, a good mix for Mastin’s future contributions to the plan would be equal proportions in the Templeton, MSDW and S&P; 500 funds.

*

Times staff writer Paul J. Lim can be reached at paul.lim@latimes.com. To be considered for a published Money Make-Over or 401(k) Make-Over, send your name, age, phone number, income, assets and financial goals to Money Make-Over, Business Section, Los Angeles Times, Times Mirror Square, Los Angeles, CA 90053, or to money

@latimes.com. You can save a step and print or download the questionnaire at http://161.35.110.226/makeoverform.

(BEGIN TEXT OF INFOBOX / INFOGRAPHIC)

The Situation

* Investors: Dona Mastin, 43, and Wayne Mastin, 47

* Annual income: About $120,000 combined

* Problem: Being overly conservative in 401(k) and in other investments

* Solution: Invest more heavily in stocks, increasing equity investments to 80% of total portfolio from about 18%. Steer clear of pre-bundled funds. Shift away from an overreliance on employer’s stock, which now accounts for about half of equity holdings.

(BEGIN TEXT OF INFOBOX / INFOGRAPHIC)

This Week’s 401(k) Make-Over

* Investor: Dona Mastin, 43, an employee with GTE

* Annual income: $120,000 with husband Wayne

* Goals: To be more aggressive with her 401(k) account--”but not in a stupid way”

Current 401(k) Investments and Allocations

* Pre-bundled “conservative” fund (all bonds): $2,700

* Pre-bundled “conservative growth” fund (bonds and stock): $1,200

* Pre-bundled “moderate growth” fund (bonds and stock): $1,100

* Pre-bundled “long-term growth” fund: $300

* Pre-bundled “aggressive growth” fund: $350

* GTE stock: $5,400

* Fidelity S&P; 500 fund: $2,500

* Fidelity Magellan: $1,300

* Fidelity Overseas: $150

Other Investment Options Available in 401(k) Plan

Fidelity Equity-Income, Fidelity Retirement Government Money Market, MSDW Institutional Equity Growth A, MAS Fixed-Income Institutional, Templeton Institutional Emerging Market, Templeton Institutional Foreign Equity, Warburg Pincus Emerging Growth

Recommendations

* Increase 401(k) allocation to 100% stocks, eliminating bonds.

* Reduce exposure to GTE stock.

* Stop relying on pre-bundled investment options. Investors typically should choose just one or two of these so-called lifestyle or asset allocation funds, not all of them.

Proposed 401(k) Allocation

* Option 1:

Fidelity S&P; 500: $12,700

GTE stock: $2,300

* Option 2:

Fidelity S&P; 500: $8,275

MSDW Institutional Equity Growth A: $4,425

GTE stock: $2,300

About the Planner

Joel Framson is a fee-only certified financial planner and certified public accountant/personal financial specialist with Glowacki-Framson Financial Advisors in West Los Angeles.