I have had it. I can’t stand it anymore. After years on the job evaluating and looking at client’s 401k’s I’ve got to tell you that for the most part they all SUCK. Yes, I am sorry, but they are absolutely awful. And let me tell you folks, I am not discriminating at all between companies or size of companies. I have clients that work in some of the largest companies and some at the smallest. In addition, I have clients who work at banks and other financial institutions who shall remain nameless. You would think that these other financial institutions would get it. Unfortunately, they don’t and are by far the worst.
However, before I go on with my rant, let me tell you the good parts of the 401k’s I have seen. First, most companies match for example 50% of the first 6% of your contributions is the most often used formula. However, there are some other formulas, some more generous than others. But what I am getting at is that there is usually some sort of “bribe” they throw to you to get you to join. Second, there is an obvious tax incentive that allows you to reduce your income by the amount of contribution you deposit into the plan. Again, not a big deal for the typical investor, but an incentive otherwise. The bad news? Well this is the part of the article I tell you why they mostly SUCK.
Somebody Else Is Becoming A Millionaire
For some reason over the years the great plan of transferring the cost and responsibility of retirement to the employee has become a huge profit center for financial institutions alike. It seems that now days 401k plans exist for one reason: to make everybody except the investor rich. What does a bad plan look like? Let me share.
•Not all asset classes are represented. True diversification using Modern Portfolio Theory is MOST OF THE TIME next to IMPOSSIBLE. Most plans have plenty of large-cap growth funds, but usually very few if any small-cap funds, international, or emerging markets. In addition too, any worthwhile fixed income. Those funds that they do have are all too commonly the expensive (see below) actively-managed funds with poor long-term performance records. It is simply impossible to build a decent, well-diversified portfolio with what’s offered.
•Only one index fund – Most plans cover the basis by adding the proverbial “one” S&P 500 index fund with a low expense ration. Again, the low cost alternative to actively-managed poor performing funds. Oh, wait, in order to use some form of Modern Portfolio Theory, I must add the poor performing, expensive actively-managed funds. GREEEEEAAAT!
•No life-cycle funds – Life Cycle Funds are all the rage these days, but apparently most program administrator didn’t get the message. Although we probably would not be investing in any target retirement funds it is a decent alternative for the neophyte investor since for the majority of workers who don’t know what they’re doing and don’t care to learn, I think they are the a good choice. Every plan should have them.
•Oh did I say AGAIN that they are SOOOO EXPENSIVE! What’s difficult is also expensive. ADMINISTRATIVE fees once borne almost universally by employers are chipping away at the returns of many investors in 401(k) retirement plans.
And the news gets worse: Most employees are unaware that they may be paying hundreds of dollars of administrative fees and even fewer know that fund companies often rebate part of the fees to employers or outside administrators.
In addition, those actively-managed funds are a lot more expensive than the prospectus states. They try to manage their portfolios in an attempt to outperform the markets; which is very difficult. The funds don’t disclose all the charges they incur when they trade; in many cases they can double the cost you think is inside the fund and its not uncommon at all even in very very large plans that it adds 50% to the cost. The hidden trading costs or what we call these transaction costs stem from not the plan participants’ doing any trading but the actual managers of the mutual funds buying stocks or bonds.
The Truth Behind Hidden Fees Part I
The Truth Behind Hidden Fees Part III
What Am I To Do?
Most of the plans and options in 401k’s suck, but the match and tax benefits of investing in a 401k are often too good to give up. However, the first thing I would do is to contact your plan administrator and SCREAM at them. Yes, you heard right. SCREEEEAM at them since it is their responsibility to know and understand these things. Tell them you want CHAAAAANGE!
Second, begin to reallocate your portfolio into low-cost index funds the best you can. If this is not available to you, SCREEEEAM at your plan administrator since he/she is not doing their job. They are supposed to be acting in your own best interest. Tell them you want CHAAAAANGE.
Third, continue to max out any investment options outside your 401k. Such as Roth IRA, taxable accounts (which will be properly allocated and invested in a globally allocated low-cost portfolio of index funds) and beef up your cash account. Ideally, you should strive to have at least 8 to 12 months of liquid reserves. If this economy has shown us anything is that we need cash reserves.
But always think that you will eventually move on and you will have the opportunity to move it out of that crummy plan and put it into a globally diversified portfolio of index funds.