Jorg Rieskamp, professor at Max Plank Institute for Human Development and Indiana University, Bloomington, published a study entitled â€œPositive and Negative Recency Effects in Retirement Savings Decisionsâ€ in the December issue of the Journal of Experimental Psychology: Applied. His study suggests that confusing choices in retirement plans can lead to mistakes in allocations. Moreover, unsophisticated investors make logically flawed investment decisions based on what happened last month in the stock market. This advisor has witnessed 401k participants choosing the top 5 performers of the previous year to make their allocations. Others may choose based on an even allocation amongst all choices if there are fewer options.
Problems usually arise when plan participants are exposed to unnecessarily high risk for their returns. Advisors call this overly high risk adjusted return. Technically speaking, your portfolio is not efficient, or on the efficient frontier.
Where do you turn to get help? Most plan administrators offer free assistance in allocations. Some even offer free financial planning, possibly from a CFP. While this may work for someone, it too is flawed. Planners/Advisors employed by a company to give free planning may be tempted to suggest strategies that benefit their employer. Some may even be given incentives. This possible conflict of interest may not be as important for beginning investors, however, as portfolios grow, fees paid to underlying investments such as mutual funds, also grow. This causes the incentive to suggest allocations in the best interest of that particular company to grow as well.
So while it may seem like a deal to get â€œfreeâ€ or a financial plan for $500 from a plan administrator, keep in mind the possibility of conflicts of interest. A better way might be to hire an independent planner to suggest allocations on an hourly basis.