BOSTON — When it comes to retirement planning, most of the focus is placed on 401(k)s. The reality is that individual retirement accounts represent the largest share of America's savings.
At the end of last year, IRAs had $5.4 trillion in assets compared with $5.1 trillion in 401(k)s and other defined contribution plans. Some 40 percent of U.S. households own at least one type of IRA, which offer tax incentives to save for retirement.
Many of these IRA holders are left to their own devices to manage their accounts. Of course, some investors are take-charge types with the ability to maximize savings without taking on too much risk. But in many other instances, portfolio management is hit-or-miss, with little attention to selecting an appropriate mix of mutualfunds or other investments.
"Many individuals are still missing out on the long-term savings benefits of IRAs, simply because they don't understand what they are and how they work," says Dan Keady, director of financial planning for TIAA-CREF, a financial services company. In a recent telephone survey of 1,008 adults, his company found that nearly half of the respondents lacked a basic knowledge.
IRAs provide individuals not covered by workplace retirement plans with an opportunity to save on a tax-advantaged basis on their own. The money put into a traditional IRA can be deducted from the accountholder's taxable income for that year, and the money isn't taxed until it's withdrawn at retirement. Also, workers who are leaving jobs can use IRAs to preserve the tax benefits that employer-sponsored plans offer.
With so many IRA holders managing accounts on their own, approaches vary widely, often to the detriment of long-term savings.
For example, surveys by the fund industry's trade organization, the Investment Company Institute, found that low-yielding money-market mutual funds make up a far larger proportion of IRA portfolios than is typically considered appropriate. For example, the ICI found that IRA holders in their 60s had invested nearly 25 percent of their portfolios in low-yielding money funds. That's four times larger than the average allocation to money funds in 401(k) accounts owned by people in their 60s.
Perhaps even more surprising, IRAs held by people in their 20s had an average 22 percent in money funds.
Among the reasons cited for the unusually high weighting: Money funds are often a default investment for small rollovers into IRAs from other investment accounts, and IRA holders may be more likely than other investors to keep invested savings readily available for conversion to cash.
Most investors use money funds as parking places for cash that's temporarily kept out of higher-yielding investments. But it's no way to build retirement savings because money funds have offered returns barely above zero for the past four years.
David Schehr, who follows investment industry trends for research firm Gartner Inc., says it appears that people "are a little better at investing for the long-term with their 401(k)s than they are with their IRAs."
He believes there's a growing need for products to help IRA owners manage accounts on their own. Among the startup firms that have launched in recent years to address this need are online-based services such as Wealthfront, ShareBuilder, Betterment and Motif Investing.
The latest entrant into this niche is Rebalance IRA, which launched in January. Its advisory board includes Burton Malkiel, a Princeton University economist and author of the investing classic, "A Random Walk Down Wall Street"; and Charles Ellis, founder of the investment consultancy Greenwich Associates and author of another renowned investing book, "Winning the Loser's Game." Both are advocates of low-cost index mutualfunds and exchange-traded funds, which seek to match market performance rather than beat it.
Customers can set up portfolios invested exclusively in ETFs, after a free phone consultation with Rebalance IRA's professional financial advisers to assess their goals and existing investment accounts. Initial calls usually last around an hour.
For a $250 initial fee, a customized account is established and the adviser maintains periodic contact with the customer. A fee of 0.5 percent of the total assets invested is charged annually for portfolio management, with a minimum fee of $500. An accountholder also pays management expenses of the ETFs. Those expense ratios vary depending on which ETFs are selected, and average less than 0.20 percent.
Because Rebalance IRA's $500 minimum annual management charge per account is steep for someone with a small IRA, it's not recommended for an account with less than $75,000.
The service includes automatic portfolio rebalancing to help IRA holders become more disciplined investors.
"People tend to buy when everybody is optimistic and the stock market is up, and sell when everybody is pessimistic and the market is down," Malkiel says. "Rebalancing makes you do the opposite of what your emotions tell you to do."
He cited findings that systematic rebalancing over the last 15 years added 1.5 percentage points to an average annual return of a portfolio invested in stocks and bonds, while reducing volatility.
Schehr, the Gartner analyst, sees significant potential for start-ups like Rebalance IRA if they can market themselves effectively. "A lot of boomers really haven't dealt with how they're managing their IRAs," he says. "And with retirement around the corner, they're finding out they're late in the game to start taking charge of their accounts."