I'll admit, I'm one of the lucky ones. I was able to retire with both a pension plan and a deferred compensation plan. Most workers usually only get one or the other.
From the employee's point of view, a pension has been the preferred method of funding retirement. You worked for 30 years for a company, and then it paid you a monthly benefit for life based on investments it had made on your behalf.
But that's increasingly rare these days. Companies have been trading in "defined benefit" plans for "defined contribution" plans. These include 401(k), 403(b), and 457 plans. Instead of guaranteeing a payout at the end, you're guaranteed the right to make a contribution every paycheck and direct the investments yourself.
In theory, we should be able to do much better directing our own finances. We have our own well-being uppermost in mind, so we know what's best for us and how much risk we're willing to accept. Unfortunately, in practice, it doesn't always work out that way. Fear and greed will force us to sell stocks at the exact worst time, keep us in them longer than we should be, or prevent us from investing in the market when conditions warrant.
Spare the rod, spoil your retirement
One of the benefits of a pension plan is the discipline with which they're managed. They regularly rebalance their assets, making sure that no particular asset class takes on too large a portion of the portfolio.
For instance, oil services company Halliburton (NYSE:HAL) has returned more than 450% over the past five years, while memory chipmaker SanDisk (NASDAQ:SNDK) has a total return of more than 700% over that period. Having these two popular stocks in your portfolio could not only create a concentration in those two positions, but also skew your entire allocation to stocks in general.
A pension plan would have conducted a rebalancing at some point to make sure its overall portfolio stayed in balance. Sure, we need to let our winners run, but when they grow to such a size, it also increases our risks. Rebalancing helps cure that.
A natural way to prevent any one class or stock from assuming too great a role is through diversification. That means ensuring that if your portfolio owns Halliburton, you don't also have huge positions in similar companies like BJ Services (NYSE:BJS) and Schlumberger (NYSE:SLB), which are two other giants in the oil services industry. Being overly represented in a sector can also increase your risk.
Balancing measured risk
A traditional pension plan would have a portfolio that was balanced at about 60% in stocks and 40% in fixed-income investments like bonds. This gives us the benefit of the performance stocks give us while reducing our risk. In an all-out bull market, your returns won't match those of the market, sure, but this also helps curb the downside, too.
We can use these ideas for our own investing inside a 401(k) or similar deferred compensation plan. The Fool's own experts at the Rule Your Retirement service have a number of model portfolios designed to combine great returns with solid investment guidelines. By making your retirement savings as bulky as possible, you won't have to rely as much on uncertain sources such as Social Security.
Find a good market index fund to represent your equity side of the equation, something like the Vanguard Total Stock Market ETF (AMEX:VTI). And there is its complementary Total Bond Market ETF (AMEX:BND) for the fixed-income side. Index funds are usually the way to go because they tend to perform better than actively managed accounts and do it more cheaply. Yet, even without indexes available, you can still construct a balanced portfolio by looking for the best-performing funds available at the lowest risk.
Final Foolish thoughts
Rebalancing our portfolios, either actively or through diversification, and building out a pension plan inside our 401(k) plans can help us achieve our retirement goals at reduced risk. Make sure you contribute regularly, at least up to any company match you're offered (hey -- it's free money!), but don't load up on company stock (no more than 10% or so).
Traditional pension plans may soon be a thing of the past. Heck, even my pension might end someday. But just because they're becoming harder to find doesn't mean we can't take the same approach to investing that made them so successful.
