At this time of the year, many people are focused a bit more heavily on their finances in order to pay their taxes. Not a pleasant task, to be sure. While you are deep in this focus, anyway, however, why not take just a few extra moments to check in on your 401(k)?

I struggle with managing my 401(k) just like everyone else. It is a huge responsibility and I am still not sure I am doing it “right.” Since this is all we have for our retirement, however, we keep trying each year to get better, learn something new and try something different to improve.

One investor mindset rule I have learned that applies especially to the 401(k) is:

Past performance does not guarantee future success but history is an excellent teacher.

 
We can’t predict what is going to happen in the stock market each year but we can at least start to recognize possible patterns for when certain types of investments do better than others or when certain types of investments do badly.

Two things I learned from 2011 about my 401(k):

1) The best investment category of 2011: Bonds. If I could turn back time and put my 401(k) investments into 2011’s best performing mutual funds, I would have put my entire portfolio in bonds at the end of 2010. If I had done this, we would have sat on a positive return of anywhere from 2-7%. Instead, our portfolio return got hammered by losses in stocks, especially international stocks, which declined up to 19%. Ouch! Of course, this year, the story is likely to be completely different and bonds may or may not be the right choice for 2012.

2) Dollar cost averaging does work! We have 3 separate 401(k)s to track from current and past employers. When I compared the investments in the different accounts, I was surprised to discover that two of the 401(k)s shared one investment in common. I cross-checked to see if the common mutual fund performed exactly the same in both 401(k)s. Interestingly, the answer was mostly yes but the only difference was that one of the 401(k)s was actively being contributed to and the other was not. The portfolio with the active contributions performed one full percentage point higher! You hear all the time that you should be consistently buying into your stocks, mutual funds, etc. constantly rather than trying to time the market. This was the first time I saw with my own money at stake, how this really does pay off. In my head, I guess I assumed that the hard part is just saving up enough money to be able to retire. This experience taught me that even if you can save up enough money, once you hit retirement, you can’t just sit on a pile of cash and draw it down. You need to continue to be reinvesting and saving even in your retirement years to keep your portfolio’s return as high as possible.

Attached is a form I prepared that mimics the analysis I just did on my own 401(k) based on my 8 Tips for Organizing Your 401(k) from last year. If you like, fill it out for your own 401(k), put it in a file folder near your taxes and each year, prepare an update to file and see how you are progressing.

• 2012 401(k) Checkup

If you need more detailed instructions about the form, below are the key steps I took to fill it out:

1) 2011 Overall Performance.  Go online to your 401(k) plan’s website to access your 401(k) plan statements for December 31, 2010 and December 31, 2011. Fill in the top blocks of the worksheet for the total balance of your 401(k) for 12/31/10 and 12/31/11 and the amount of money you and/or your employer contributed to the plan in 2011. (If you have more than one plan, repeat for your other plans.)

*Note: if you do nothing else, it is a good idea to make sure you double-check you got the correct employer match to your plan in 2011. If you don’t even know what the amount of the match should have been, send an email to your HR department to ask. From experience, sometimes employers have computer glitches or make mistakes. Double-check to make sure and if there is something wrong, let your HR department know.

2) 2011 Return.  Calculate your annual return using a calculator or spreadsheet, using the formula:

2011 return = ((2011 balance/(2010 balance+Self Contributions + Employer Contributions))-1) *100%

3) Brightscope Rating.  Look up the Brightscope rating for your plan at brightscope.com and fill that in the last block of the top table.

4) Performance of Individual Mutual Funds.  The middle section of the worksheet is optional, but helpful to determine how individual investments within your plan are performing. Again, all you generally need to do is look at your statements for 12/31/10 and 12/31/11. Most 401(k) plans will categorize these investments for you as “Stable Value,” “Bonds,” “Large Cap” etc. In the middle blocks put in the name of each fund and calculate the return for each fund using the 2010 beginning balance, 2011 contributions and 2011 balance, the same way as described above for the overall plan. In the last box you can also go to Morningstar.com and look up the Morningstar rating for each fund. The Morningstar rating system generally gives a star rating for how the fund has performed over the last several years and sometimes a rating such as gold, silver or bronze for how Morningstar thinks it will perform in the future. Interestingly, these ratings don’t correspond exactly to how our funds performed but they are at least one objective guideline to take into consideration. Also, as Ramit Sethi notes in his book, underperforming funds often get closed down and transferred to new funds at the end of each year. You might want to note how many of your funds did this.

5) Look at the Long View.  The Retirement Goal Status box asks you to make a goal for how much you would like to live on (in today’s dollars) at retirement each year and how many years you estimate you will be in retirement. Plug these numbers into a calculator such as this one  to determine how much total money you will need by the time you retire. It will be a huge number but don’t be afraid of it, just write it down. Use the same calculator to figure out how much you will need to save each month to hit your target. Calculate one number using a generous return of 8% and another using a lesser return of about 5%.

6) 2012 Contributions.  Then write down how much you estimate you will actually contribute to your 401(k) based on your current paycheck deductions and your 2012 estimated employer match. If your number is nowhere near what the calculator indicates you will need to save this year, try not to panic. Understand that retirement saving is a long-term game. If you can’t hit your savings target this year, you just need to tack it in the back of your mind that you will have to put aside even more in the future to make up for it or adjust your eventual goal downward.

7) Loan and Hardship Withdrawals.  Finally, in the last box, it is a good idea to check in to see what the loan and hardship withdrawal provisions are for your 401(k) just in case you should ever have to withdraw the money for an emergency. It is almost always a bad idea to have to take a loan or withdrawal from your 401(k) but if you are truly desperate, it is a resource available to you. The loan and withdrawal provisions are generally available online in the same place you access your 401(k) balance and other data.

I know this is a lot and overwhelming to some. If it is too much for you, perhaps do just the top box and set it aside. Or print out the form, print out your 12/30/2011 401(k) statement, put them in a file folder and make a note to do it next year.

How do you keep track of your 401(k)? Please share in the comments.