Retiring? Avoid This Big 401(k) Rollover Mistake

Photo by Kenny Eliason on Unsplash

Three-quarters of retirees “de-risked” their portfolio by reducing stock exposure when they quit working and rolled their workplace 401(k)s to an IRA.

The de-risking dilemma

That may seem like a good idea. But unfortunately, in some investment environments, making big, sudden changes to your fund mix at retirement can be a major mistake, according to recent research by J.P. Morgan Asset Management. The new conclusions draw on an Employee Benefit Research Institute (EBRI) database of more than 23 million 401(k) and IRA accounts, and JP Morgan Chase financial data for roughly 62 million households.

The new research does confirm that many people, as they head into retirement, suddenly make major changes to their investment mix. Seventy-five percent (75%) of retirees studied between 2013 and 2018 significantly “de-risked” their portfolio – or made substantial cuts to stock weightings – when they retired and rolled their 401(k) balances to an IRA.

Why do so many people de-risk at retirement?

There are many reasons for this. Investors have much more control over investments in an IRA, while workplace 401(k)s often offer only a smattering of funds. Rolling money from a 401(k) to an IRA permits greater freedom of choice, and could prompt major fund rebalancing as soon as the money is free to move.

Another reason? Many 401(k) participants tend to ignore their 401(k) accounts – and investments – as long as they work. But the minute they retire and start needing to draw income, they become motivated to take a more active role, leading them to make significant investment changes, some of which may not be well thought out.

According to the research, the typical retiree with 40% to 100% stocks in their 401(k) mix reduced their equity exposure by 17% on average when they rolled their assets to an IRA. This reduction in stocks was most pronounced in people who held highly aggressive 401(k) portfolios with 80-100% stock weightings before retirement.

It seems to make sense that the average retiree might want to dial back on risk. Risks we can live with while working can become uncomfortable the minute we stop working and contemplate monthly withdrawals from our portfolios. Although on the flip side, some retirees – specifically those with 40% or less in stocks – moved to increase their equities at retirement.

But ideally, it’s best to avoid sudden, major shifts in allocation if at all possible. When 75% of retirees make significant changes in their investment mix as they take control of their former 401(k) accounts, both up and down the risk scale, it could quite possibly be a knee-jerk reaction to what they ‘think’ their retirement portfolio should look like, rather than a true understanding of what portfolio would serve their interests best in retirement.

Why those big portfolio changes can be a problem

Whether new retirees lowered their stock weighting or raised it, one thing was made clear in the research study.

Making big investment changes to your asset allocation at an inopportune time can be very harmful. Workers who retired and de-risked their portfolios by cutting stock holdings in March 2020 – at exactly the moment when the COVID pandemic was roiling the stock market – made a potentially lasting dent in their long-term net-worth.

The truth is that finding the right investment mix is both an art and a science. There is no simple “one size fits all” formula that suits all investors or all retirees. Cutting back on stocks simply because you stop working is not necessarily a wise decision, especially when your retirement can now last thirty to forty years.

The best allocation for you depends on your lifestyle, income needs, risk tolerance, and the other financial resources you have available. As the J.P. Morgan research shows, while some people do need to “de-risk” at retirement, others would do well to give their stock holdings a timely boost, or stick with a healthy dose of stocks to counteract inflation.

The Takeaway: When adjusting your portfolio, you often do best taking baby steps. Avoid sudden or sizable asset allocation changes, especially when the market is under major stress, as it was in March 2020. As scary as market upheaval can be, it’s not a good time to make dramatic or emotional decisions. If your emotions get in the way, consider turning the reins over to a professional who can make insightful decisions about your financial future with more objectivity. Sometimes, the closer you are to your portfolio, the harder it is to make smart choices for the long-term.

About Mari Adam

Mari Adam, Certified Financial Planner™ has been helping individuals and families chart their financial futures for over twenty-five years. Have a question about your financial situation? Ask Mari!

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