Jul

25

401k: If I Where Employed by EMC

July 25, 2005 | Comments Off

(Originally posted on the Anes Blog)

If I became an EMC employee, first of all, I would be happy.  I trust the company to do well.  It has a solid and expanding product suite that compensates for a decline on basic storage.  The need for massively large and complex, highly available, and highly reliable storage systems will just increase as people try to make more digital data available for business applications as well as for the entertainment industry.  This company is benefiting from increased IT spending that was being held back during the recession years.  Although Earnings Per Share on 2000 and 2001 where nothing to write home about (unless it was to receive some family emotional support), they have been steadily and dramatically increasing year over year since 2002.  Cash flow, Revenue,  and Operating Income has steadily increase over the years, since 2002.  The fact that Standard & Poor’s believe on it (Strong Buy 5 star) helps me feel better about it.  I do hold 500 shares of it, and if I was an EMC employee I would probably hold some stake in the company also:  but not more than 10% of my total net worth!  Most probably I would take advantage of Options and ESPP plans, and avoid investing too much more inside the 401k on EMC stock.
The question my EMC friends may have then is where should they invest the money they put on the 401k.  Given the fund options an EMC employee and friend sent me, this article tells about my approach.  It may even be useful for non-EMC employees as investment options may be similar among different companies 401k plans.

If I wanted a hands off approach, I would simply put everything on one of the Fidelity Freedom 20XX funds.  They are a professionally managed fund of funds.  They invest the money in what some wise people at Fidelity Investments consider the perfect mixture of investments if you plan to retire in 20XX.  (For example, if you are 25 years old, and plan to retire at 60, you may want to take 2040 Fund since 2005 + 35 = 2040).  The growth and income received from these funds is fairly conservative (low), as is the risk.

I like to have some more control of my finances, and I think I can do better than a long faced Fidelity wise person can.  This is one of the few personal complaints I have about 401k mutual funds, that I can’t have total control about the specific companies on which I invest.  However, for the uninitiated or for the person who doesn’t want to be paying attention to every single stock news and earnings report, well managed funds are an advantage.  For the majority of people in this nation this fits the bill, and so thought our congressmen when they designed the 401k plans, and I do agree with them (I just wished they had thought of higher contribution limits).

Not all funds are created equal, and there are key items that I look in them (among others):

  • They must be better than average, a lot better.  A name is not important.  The good intentions they ave are not important either.  Execution is the key.
  • They must have low fees:  I am willing to help the fund manager pay college tuition for his/her kids, but not a Lamborghini on his/her garage.  Good fund managers should be rewarded by the volume of new investors.  And volume only comes with performance.  Let them work for their money, and lets keep some more of our money on our pockets.  I usually stay away from sales fees, redemption fees, 12-b fees, and initial fees.  Look for low management fees and expense ratios.  Funds that seem fairly good may have 5% upfront fees:  money that is gone forever, and not into your investment strategy.  Fees may or may not be compensated by increased performance over no-load funds, but usually they aren’t.  Fortunately, most 401k plans offer no load funds; you just have to look carefully, as financial companies prefer you to use the high fee funds and will market those more agressively.
  • Their strategy should be aligned to your strategy and risk tolerance.  If you do not trust a particular market, no wise advice from a big financial house should make you go into that market.  Metals (gold, silver, platinum) for example are not in my investment strategy:  they are for giving gifts to my wife if she is nice enough (so far she has gotten little of it, even when she has been really nice), and for shiny and pretty collectible coins (of which I have very little as well) — neither of any investment consequence for me.

When I invest on mutual funds I like to start with a core, catch all fund.  Any investment not directed into a particular vehicle goes exactly there.  This fund should reflect my main investment goal.  Since I am a strong believer in owning a piece of the economy, I like to own the best companies in the US.  For me this is usually means a fund that closely matches the Standard & Poor’s 500 Index like the  Fidelity Spartan 500 Index Fund.  In the long run around 80% of the mutual funds under perform it, its fees are around 0.10% to 0.24%, and it closely matches my strategy:  own the best companies in the US Economy.  It is also the only investment choice I have in my 401k plan (Computer Associates 401k plan investment choices are rather limited and this is the absolute best option there).

On bull markets like the one we had on the 90’s, funds with small market capitalization companies may do very well.  Such small companies may be growing fast, and so the perceived value of their stock.  If you feel like there is a bull market coming, you may want to consider these funds.  I do not believe in timing the market, but you can benefit from this effect if you invest in funds that cover broader investment choices than just the Standard & Poor’s 500 Index.  A good choice could be the Fidelity Spartan Extended Market Fund, which invests in around 4500 companies, a lot broader than those following the SP 500 and more susceptible to the price increases (or decreases) of rapidly growing companies.

I do believe in a balanced investment strategy.  When you look at all of your Net worth it should be invested in more than one asset class.  Your house for example is a Real Estate investment (although some people only count it if they can sell it and move to a less expensive one).  Emergency funds are a cash-equivalent.  The stocks you get from your ESPP program are an equity investment.  Remember to add all assets and use them when determining if your portfolio is balanced or not.

A very important goal of every investment strategy should be to produce a steady stream of income at some point.  Since a 401k is not designed to be an income source when you are younger than 60 years old, you should concentrate on Growth as your primary objective if you are still young.  Even then, income funds usually provide some stability to the portfolio:  they provide income even if the market conditions are lousy.  An income fund usually invests in securities that provide dividends.  An Equity Income fund invests in stocks from companies willing to share their wealth with their owners (shareholders).  Cash is difficult to fake, either the company can produce and share its cash, or they can’t.  This type of fund is a good point to start diversification within the 401k, and should also play a bigger role as you approach retirement age.  The Fidelity Equity Income and Fidelity Equity Income II funds do show real cash (dividends), more than most equity funds in the available funds for EMC employees.  However, the less than 2% dividend yield leaves a lot to be desired, and I would consider them as a way to validate the stability of the companies on which the fund invests, but I would not depend on it as a steady stream of income if I was approaching retirement age.

For younger investors looking for a Growth Fund, the Goldman Sachs Mid Cap Value (Institutional Shares) Fund is hard to beat.  It does however has beaten the SP&P 500 consistently by searching for medium sized companies (not necessarily those on the headlines every day) that appear to be undervalued.   Apparently they have been successfull at that.  Value investing is a better way of adding growth than watching the media for hot companies.  This fund, if it was available to me, would certainly be on the list of investment choices I would pick.  Another good option would be the Fidelity Low-Priced Stock Fund, with very similar characteristics but usually concentrating in smaller companies:  more volatility, usually for the better.

The US is not the only place to invest.  There are a few good companies who are not based here.  You may want to participate in their success by investing in them through an international mutual fund.  There are risks associated with them, including currency valuations, political stability (a country may intensify their socialist policies for example), or even war — usually risks that are less important when you invest inside the USA.  I usually keep my money away from international issues but I will probably put some of it there as my investment capital grows.  If it wasn’t because of its upfront fee, I would have suggested AF Europacific Growth as it concentrates in almost stable international markets.  Since it has a high upfront fee I would stay away from it and add international exposure outside of the 401k plan.  Even then, please remember that International stock funds require a better stomach than local ones.  The multiple risk factors make them very volatile.

Nor stocks are the only place to invest either.  Real Estate, for example, could be a good place to park your money.   Most of us have parked a lot of it on our houses already.  The Vanguard REIT Index is a very low management fee, high yield (4.5% dividends) fund that has experienced impressive growth on this hot Real Estate Market by investing in Real Estate Investment Trusts — companies that hold, manage, and exchange real estate properties.  Those approaching retirement age can benefit from rental income (that 4.5% dividend yield) without having to worry about fixing rental properties every time the tenants break them.  Important risks to consider are the apparent “froth” the real estate market may be experiencing nowadays (slightly overvalued).

What about bonds?  I am slightly reluctant to use bond funds.  Most mutual fund bonds do not behave like a bond.  The purpose of a bond is to loan money to a company or entity and expect the principal and some interest back.  A nice idea, but bond traders tend to speculate if the interest rates and credit ratings of companies go up or down, and start selling the bonds at a premium or a discount.  Most bond mutual funds end up behaving like speculative secondary markets that, although profitable sometimes, not true to the investment strategy they portray.  My advice:  stay out of bond mutual funds (there are some exceptions).  If you want to invest in bonds do so outside of your 401k.  A good place would be Treasury Direct, where you can loan money to Uncle Sam with very low (or no) transaction fees.  However, if I had to invest on a bond fund on the EMC 401k plan I would choose the spectacularly performing, low fee PIMCO Total Return Fund with a yield of around 2.5% and a slight growth that makes it a good choice for a person expecting a steady stream of income in a few years.

Jose’s picks for the EMC 401k Plan:

NOTE:  Although I hope people find this useful to help them make decisions, this is just an opinion and should not be considered as investment advice.  Readers should assume all risks associated with investing decisions based on the information provided on this article.

Comments People Have Left:

I like your recommendations. I happen to have a 401(k) at EMC from when I worked there 4 years ago. Just as an example of a slightly different perspective on this plan, here are my current allocations and balances.

20.04% SPARTAN US EQ INDEX $1,785.05
19.94% FID PURITAN $1,776.10
19.72% PIMCO HIGH YIELD ADM $1,756.50
10.11% FID SMALL CAP STOCK $900.62
10.09% AF EUROPACIFIC GTH A $898.58
10.07% JANUS WORLDWIDE $897.40
10.04% TEMPLETON FOREIGN A $894.52
100% $8,908.77

This fund started out with about $6500 in 2001….

FYI about the AF Europacific fund – even though it has an up front fee, once you are within the EMC 401(k), you don’t end up paying it. Same with the Templeton Foreign A fund…. I think its because the members of the EMC 401(k) fund own so much of these funds in aggregate, there is enough volume that the fees are exempted.
Spike – 29 07 05 – 16:53

Hi, I like your blog.

One comment I want to add about small/large caps or growth/value, is that there are some options for not trying to guess within those classes and to just buy the broad US stock market: for example, the Vanguard Total Stock Market Index (http://finance.yahoo.com/q?s=vti), which tracks the Wilshire 5000.

And as you implicitly mentioned, it is quite risky to be owning stock in the company you work for. If the company does very badly, not only do you risk losing your job but your investments have lost a significant amount of money, too. If anything, it is more of a reason to invest in less correlated stocks (ie everything exception technology). But I do see advantages to holding positions in your own company: a greater incentive to perform well as an employee, and a greater feeling of connection to the company you work for.

Good luck!
Jason – 02 08 05 – 08:37

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