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My company offers a deferred compensation plan that offers several mutual fund options. What criteria should be used in determining the amount of compensation to defer, on an annual basis, and which funds should be selected - the options are pretty standard?
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I have been in deferred compensation for ten years. Your question is complicated but I will try to answer in brief. The amount that you can defer is no more than 8000 per year or 33 1/3 % of includible compensation which ever is less. 401K ,403b and SEP plans count twards those limits. The longer the time horizon you have choose more agressive options. The shorter choose a mix of agressive and conservative options. In my opinion 5 years or longer is a long time horizon. Look at the funds long range and intermediate returns and the internal cost of the fund, even in the same deferred comp. plan some funds are cheaper than others. A good plan can offer 50 or more choices.
Choose a mix to balance out your risk. There are many books that can help there. Be patience the market is volatile , time is needed to make money.
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Generally, Fools recommend putting as much as the company will match - the match should make up for whatever underperformance mutual funds have builtin. If no match there is little advantage except for the larger amount defered.

Pick a fund that matches the S&P-500 if possible. They perform the best.

Jim
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I think you've gotten good advice here, I would like to add a few points.

I agree that as a minimum you should invest as much as will be matched by your employer. Think as the matched porting as a raise.

I always stretched for the maximum allowed. The tax defered aspect of 401K's means that your take home pay will suffer far less than you might think.

Invest in the S&P500 index if it is available. Read the book, "The Motley Fool Investment Guide" to see why. 90% of the mutual funds haven't outperformed the index. If you must pick a fund, go for the one that has the highest historical returns. This will probably be a growth fund. I don't believe the "balanced" or "income" funds provide any more safety against a falling market than do growth funds. Growth funds generally outperform other categories.

The "risk" they try to protect you from is a falling market. The investment community seems to ignore the much greater risk of inflation. Inflationary periods have occurred far more frequently for much longer periods than do bear markets. To protect against inflation, you need to earn the highest return possible in a mutual fund. Remember, they are all very diserfied and "safe". They are all vulnerable to market drops since they are so diserfied, they are essentially buying the market.

Chuck
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My company offers a deferred compensation plan that offers several mutual fund options. What criteria should be used in determining the amount of compensation to defer, on an annual basis, and which funds should be selected - the options are pretty standard?

As far as how much to contribute, the Foolish thing is to put in at least whatever your company will match. (I have a deferred comp plan with the State of Florida, which generously matches absolutely nothing for me, so I don't have to worry about that.) After you've put in the maximum that your company will match, you need to look at your other options. If your marginal tax rate is 15%, I'd recommend fully funding a Roth IRA. If your tax rate is higher than 15%, it may be better to add more to your deferred comp, as you would essentially be able to invest 28% more. On the other hand, with a self-directed Roth you could probably beat your mutual fund returns, and over a long time period you may be able to make up that 28%.

As far as the mutual funds go, I'd agree with everyone else who's suggested index funds. S&P 500, with maybe some total market or small-cap index funds thrown in for diversity, if your plan offers them.

-john
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jjjjjj24 writes:

My company offers a deferred compensation plan that offers several mutual fund options. What criteria should be used in determining the amount of compensation to defer, on an annual basis, and which funds should be selected - the options are pretty standard?

Usually, deferred compensation plans are a general obligation of the employer. That means that unlike with a 401k, the money you leave with your employer is not required by law to be funded. If the company goes bankrupt, you get in line with all the other claiments. So, take your company's financial health into careful consideration. The terms of the deferral are essentially a contractural agreement between you and your employer. Although, I'm sure the IRS has something to say about it.


SCullum writes:

I have been in deferred compensation for ten years. Your question is complicated but I will try to answer in brief. The amount that you can defer is no more than 8000 per year or 33 1/3 % of includible compensation which ever is less. 401K ,403b and SEP plans count twards those limits. The longer the time horizon you have choose more agressive options. The shorter choose a mix of agressive and conservative options. In my opinion 5 years or longer is a long time horizon. Look at the funds long range and intermediate returns and the internal cost of the fund, even in the same deferred comp. plan some funds are cheaper than others. A good plan can offer 50 or more choices.


I'm a participant in a deffered compensation plan myself. My employer is cash rich, so I don't worry much about their ability to pay.

Unlike in SCullum's case, I'm not limited in the amount I'm allowed to deposit. I put in 50% of my salary in addition to the 401k.

Both state and federal taxes are deferred until I begin withdrawing the cash. I'm required, either by law or company policy, to begin taking the salary in equal payments as soon as I leave the company's employ. Since I will retire soon, and will have several years before I wish to dip into my IRA and until I begin receiving SS, that works perfectly for me. My tax bracket will be significantly lower than it is now, another big plus.

We are offered a full spectrum of mutual funds, very much like in our 401k plan. Just recently they have added an index fund to the mix (hurrah!); As soon as I've checked it out, I will probably transfer 100% of my holdings into that.

I do not feel the need to diversify among mutual funds. An S&P500 index fund offers more than enough diversification for me.

Cheers,
GW







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