10 Signs Your 401(k) Plan Is a Clunker

what your 401k plan doesn't want you to knowWilliam Bernstein is one of the most respected financial minds of our time. His book, The Intelligent Asset Allocator, should be read by every investor. In an insightful commentary entitled What the Investment Industry Doesn't Want You to Know, Bernstein observes that investors "can only positively impact one aspect of investment performance -- your allocation of assets among broad asset classes." Stock picking, mutual-fund picking and market timing are "irrelevant."

Keep this advice in mind, since it is the primary reason why your 401(k) is probably a "clunker." Here's a checklist of others:

1. High costs: Low costs correlate directly to higher returns. The total cost of your plan should not exceed 1.50%. By "total cost," I mean the expense ratio of mutual funds in the plan, record keeping, custody, administration fees and advisory fees.

2. No investment advice: Advisers to 401(k) plans are well compensated, yet most limit communications with plan participants to "education." Your adviser should give investment advice. Most advisers won't because of the potential liability. If the investment options in the plan were in the best interests of plan participants, they wouldn't have this concern.

3. Revenue-sharing and hidden mark-ups: Brokers and insurance companies typically extract payments from mutual funds that want to be included as investment options. How objective can their advice be if they are receiving these payments? They also mark-up management fees charged by mutual funds. I reviewed a plan that included a Vanguard Target Retirement Fund, which Morningstar reported had an expense ratio of 0.18%. The plan was charged 0.93% for this fund. This difference comes out of your returns.

4. The plan adviser is not a "real" fiduciary: Brokers and insurance companies misuse the term "fiduciary" in describing their obligation to the plan and plan participants. The only real fiduciary is a 3(38) ERISA fiduciary. This kind of fiduciary accepts 100% of the liability for the selection and monitoring of investment options in the plan. I have never seen a 401(k) plan where a broker or insurance company agreed in writing to be a 3(38) ERISA fiduciary. Any other designation of "fiduciary" is meaningless.

5. Retail share classes are in the plan when institutional classes are available: I recently reviewed a plan that had thirteen mutual funds as investment options. All of them were retail shares. Every one of these funds had institutional shares available. What's the difference between the two share classes? The retail shares have higher management fees. Otherwise, they are exactly the same. The only reason to include retail shares when less expensive institutional shares are available is to increase fees and lower returns. This practice is indefensible.

6. The money market fund has high fees: In many plans, the money market fund is the default where assets are placed if the plan participant does not make another choice. The management fees charged by money market funds can really impact your returns. If the money market fund in your plan has an expense ratio higher than 0.25%, it should not be in the plan.

7. The mutual funds in the plan have high fees: Brokers typically populate fund options with high-cost, actively managed funds (where the fund manager attempts to beat a given benchmark). The fees charged by these funds range from 1.5% to 2% (or more). A blend of comparable index funds has fees under 0.50%. The difference comes right out of your returns.

8. Mutual funds in the plan underperform their benchmark: Most actively managed mutual funds underperform their benchmark index. I looked at a plan where over 70% of the funds failed to equal their benchmark. Why are those funds in the plan when low-cost index funds will equal their benchmark 100% of the time (less low expenses)?

9. Funds drop in and out of the plan: A charade takes place at most companies with 401(k) plans. The investment committee meets periodically with brokers advising the plan to decide which funds will be dropped and which ones will take their place. This makes everyone feel they're doing something useful, but it's a useless activity. Past performance is not an indication of future performance. Poor-performing funds may or may not outperform in the future. Stellar-performing funds typically underperform in the following five years. It also ignores a key issue: If the broker really had the expertise to pick superior funds, why is this exercise necessary at all?

10. Many investment options: Many fund options confuse plan participants. Few participants know how to put together a risk-adjusted portfolio in an asset allocation suitable for them. Instead of offering a boatload of funds, your plan should have a limited number of pre-allocated, globally diversified portfolios of stock and bond index funds, ranging from conservative to high risk. Plan participants should fill out a simple asset-allocation questionnaire to determine their risk level. They should then select the portfolio suitable for them. If all 401(k) plans followed this practice, returns would increase significantly.

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TITAN

This guy is 10% on target and 90% in the ditch. The investment piece is the easy fix. Each plan as a different twist in what it needs to be successful. Get your nose out of your press clippings and get your hands dirty!

September 29 2010 at 7:36 PM Report abuse rate up rate down Reply
Ed

It seems that many wall street people have sold the public on the idea that Social Security is a ponzi scheme. The truth is that it is the most successful program that has ever been enacted by our government. Many governments around the world are using our Social Security System as a model for their system. They say that Social Security should be investing in more risky stocks and bonds to improve the returns. When I was young I often thought why we didn't invest into more risky securities. Well the last 10 years cured me of that thought. It truly would of went into the red with riskier investments. Also to the talk of Social Security being broke, We have a surplus in SS well into the 2020s. Even if the surplus was used and we could only use the money that is being collected we would still be able to collect 75% of the money you would be eligible for. It is true that we need to make some minor changes to be able to collect 100% after the surplus runs out. So don't panic SS is a lot more secure than almost any company that you could name.

September 06 2010 at 11:16 PM Report abuse +4 rate up rate down Reply
Lawrence

Until they reform Wall Sreet I won't worry about return on capitol...I'll worry about the return OF capitol...

September 06 2010 at 9:39 AM Report abuse +7 rate up rate down Reply
ShafqatMir

i have 2010 thousand dollars in 401 k plan, any advice good or bad?

September 06 2010 at 9:33 AM Report abuse rate up rate down Reply
Bdcelina777

Anything that is covered by ERISA is CRAP!

September 06 2010 at 8:47 AM Report abuse rate up rate down Reply
richord

The best advice these folks could offer the public is: 1. Become an investment advisor, investment banker or investment news letter writer. You give advice, collect fees, independent whether your clients make or lose money and you gamble with other people's money. You get to have fun, with no risk and make money. The perfect job! 2. Investing is all luck unless you are on the “inside”. Being inside requires that you join one of the esteemed financial institutions and have a job as described in step 1. 3. The “best book” to read on investing is A Random Walk Down Wall Street. It states the fact that over long periods of time, investing is random confirming step 2’s assertion that investing is all luck even for those who have jobs in the industry. 4. If you think you’re a successful investor that will change when you lose money. It’s just a matter of time. 5. If you keep making money in spite of the rules above, you are the world’s next Madoff. 6. Don’t believe anything you read, including this. None of us have a clue what we’re talking about but we certainly sound convincing!

September 02 2010 at 12:44 PM Report abuse +2 rate up rate down Reply
Veekini

Harold, you can't even spell

August 31 2010 at 5:29 PM Report abuse rate up rate down Reply
jflconsult

Some of the points make sense and some don't. Generally smaller companies 401(k) plan are more expensive mainly because they do not have much money. The larger the plan, generally the lower the expenses. You also complain about the fees and reference an Vanguard index fund and institutional shares, but you are also saying that employees need advice...who's going to pay for that if the advisory fees are not included in the funds? There definitively needs to be better disclosure on the costs but you need to realize that their is a cost of the distribution. In addition, plan sponsors generally can change their advisers at any time so if they are not doing their job, fire them!

August 31 2010 at 1:59 PM Report abuse rate up rate down Reply
presch597

As bad as any 401(k) may be, every one of them is far better than the ponzi scheme known as "social security".

August 31 2010 at 1:34 PM Report abuse -1 rate up rate down Reply
HAROLD

THIS IS TIPICAL OF MOST AMERICANS COMPAINING ABOUT 401K IF YOU ARE NOT SMART ENOUGH TO TAKE CARE OF YOUR MONEY YOU DONT DESERVE IT . EVERY ONE WANTS THAT FREE HANDOUT DONT WANT TO TAKE CARE OF ANY THING THEMSHELVES COMPANY NOT DOING ENOUGH FOR YOU GOVERMENT NOT GIVING YOU ENOUGH THE PEAPLE OF AMERICA HAVE BECOME LAZE AND DONT WANT TO DO FOR THENSELVES WANT GOVERMENT OR SOME ONE ELSE TO DO OR GIVE THEM EVERY THING ITS BECOMING WHERE I AM ASAMED FOR YOU PEAPLE

August 31 2010 at 12:48 PM Report abuse -4 rate up rate down Reply
3 replies to HAROLD's comment