This post was inspired by a conversation I had with a good friend that is trying to better his life by finding a good paying job with UPS. UPS offers a nice pension plan if you work for the company for 25 years or until you are 55 (with a certain minimum number of years serving). I hope this works out well for my friend, but I explained to him the importance of having a diversified retirement portfolio. You do NOT want all of your retirement savings tied up in a company pension plan.
Is diversity in your retirement portfolio necessary?
The answer is YES. I will argue why throughout the rest of this post. This post will:
Review what diversification means and its importance
Provide examples of companies that have/had pensions plans
Discuss action you can take to diversify your retirement portfolio
Review my current investment diversification
The importance of diversification
It is important to diversify your retirement portfolio because in doing so you reduce risk. When you invest in your 401(k), you have the ability to diversify your portfolio into bonds, stocks, and cash. A young person may have a higher stock allocation and lower bond and cash allocation compared to someone nearing retirement that will have a greater bond and cash allocation in their portfolio.
However, it is important to note that your 401(k) is just one piece of your retirement portfolio. You want to have different buckets you save into for retirement, with your 401(k) being one of those buckets. Other buckets in your retirement portfolio may include company pension plan or stock plan, IRAs, HSAs, real estate, 529 savings plan, or a taxable savings account. Next, I will provide a few examples of why diversification is important.
Company pension plans gone bad
Let’s take a look at some examples of large corporations that offer(ed) a company pension plan or certain benefit plans, but changed their plans – not for the benefit of their employees…
Enron filed for bankruptcy in 2001. Their stock went from trading in the $90s in 2000 to less than $1 in December of 2001. I’ll save discussing the ridiculous wages the executives had for a separate post to elaborate how this is a big problem in the U.S. But, to quickly note – in 1998 the 200 highest paid employees at Enron made $193 million in total compensation. By 2000, those 200 employees made $1.4 billion in total compensation, which is an increase of almost 10x!
Now, the worst part of all of this was what happened to the hard-working people at Enron that didn’t make millions of dollars. According to Wikipedia, 62% of the 15,000 employees had all of their savings tied up in Enron stock, which meant that anyone that was close to retiring now had to figure out a plan.
Early last year, GE saved $3.3 billion by cutting its healthcare support for their employees in retirement. Employees that were saving with the notion that most of their health care costs would be covered by GE are now stuck scrambling to find a way to cover health care costs.
IBM had a company pension plan, but they changed to a company 401(k) plan with a company match. This isn’t a big deal because most companies have gone this route. What is interesting is that IBM only pays out the company match at the end of the year.
The two issues that affect employees are 1) the employees miss out on the company match investing in the market throughout the year, and 2) an employee needs to stay on board for the entire calendar year or they do not get the match. In addition, IBM can let go of employees before the end of the year and they do not have to contribute the match.
So, what can you do if you are heavily invested in your company’s pension or stocks? TAKE ACTION!
If you haven’t checked out my post where I review the e-book 99 Minute Millionaire by Scott Alan Turner, please check it out here. This book is an excellent read if you are new to investing and you want to get started. Here is a summary of Turner’s principles of investing:
Implement good asset allocation (e.g. 60% stocks/30% bonds/10% cash as a young person or 30% stocks/ 50% bonds/ 20% cash when you are older)
Use passively managed index funds with low fees
Ensure you have good diversification (e.g. not having all of your money tied up in a few stocks or a company pension plan)
In addition, Turner recommends three options for getting started:
Use a target date fund. With a target date fund, you select the year in which you plan to retire, and the fund automatically adjusts your risk/reward level based on how close you are to your retirement age. Target date funds are easy to use, and they do not require you to pay someone in advance for a recommendation.
Robo-advisers. These advisers are online resources that provide recommendations and a platform to begin investing. Betterment and Wealthfront are examples of Robo-advisers. Turner recommends Robo-advisers if you are setting up a Roth IRA, IRA, or a regular investment account.
Three -fund portfolios. The three funds consist of total bond market indexes, stock market indexes, and total international stock market indexes. To start, follow these two steps:
Choose an investing company like Fidelity or Vanguard
Pick your investments
Here is the current diversification I have from all of the investments and property we own. You can see my 401(k) and equity in my home (which I use a very conservative number) are at the top. My goal is to increase the percentage that our Roth IRAs and HSA make.
Our emergency fund and personal property will likely decrease in percentages over time because they are adequately funded. My ESOP is nice because I do not have to contribute to it or purchase stock – shares are distributed to all employees each year (read more about ESOPs here). Finally, cars should NOT be considered an investment, but they do have a value, which decreases each year.