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1. "We're making a mint on your 401(k) even if you're not."
The number of 401(k) investors has soared in the past decade, to nearly 50 million from 28 million, according to Cerulli Associates. That torrid growth has created impressive efficiencies for the folks who run your plan. But it doesn't mean those savings show up in your account; in fact, they could be coming straight out of it. In a practice known as revenue sharing, providers get a cut of the expense ratio on the funds in your 401(k) to cover day-to-day "administrative costs." Since the fee is charged as a percentage of assets, that revenue increases as your 401(k) grows, even though those costs stay virtually the same.
But the gravy train may be coming to an end, as these and other fee arrangements in 401(k)s are suddenly drawing attention. Companies, who have the legal responsibility to ensure reasonable fees, are facing lawsuits onthe issue; the Labor Department is mulling new disclosure rules; and New York Attorney General Eliot Spitzer is sniffing around 401(k)s. "Plan costs will become more transparent," says Matt Gnabasik of retirement-plan consultancy Blue Prairie Group. "Any time you have more transparency, it tends to lower fees."
2. "You're buying wholesale, but we're charging you retail."
With $2.4 trillion sloshing around in 401(k) plans, you shouldn't be paying the same fees for a fund that you would if, say, you bought it on your own. But in reality, you might be. Here's how it works: Asset managers sell mutual funds in different share classes, each of which has a different fee structure. From the most expensive to the cheapest class of funds, the range can be as much as a full percentage point, says Yannis Koumantaros, chief pension consultant at Spectrum Pension Consultants. That works out to an extra $1,200 a month in retirement for a 30-year-old with $50,000 in his plan and contributions of $3,000 annually. "You're talking about a difference in your quality of life at retirement," Koumantaros says.
What plans have the highest fees? Usually, those with the fewest investors. Small plans are expensive to run, so they often have to accept costlier fund classes. But your employer can renegotiate for cheaper options as the plan expands: Those holding between $10 million and $30 million per asset class should lobby for institutional funds, which are cheaper on average than traditional mutual funds.
3. "No one in his right mind would buy these funds given a choice."
Confused about why your 401(k) doesn't offer the top funds? That's because your asset manager may not have them in each category it might offer stellar large-cap stock funds but mediocre small-cap picks. And providers may charge extra for better alternatives from other sources. "If you see some lousy funds from the company that's providing the plan, that's probably why," says Russel Kinnel, research director at Morningstar. Another issue: Funds need to be big enough that they don't get swamped by the influx of 401(k) money, but for mutual funds, size is often a handicap. Take Fidelity's Magellan, the poster child for asset bloat. The fund is a mainstay of 401(k)s, but has underperformed the S&P 500 for years. It closed to new retail investors in 1997 but continuesto accept new 401(k) money. The current manager has revamped the strategy, but only time will tell if Magellan can return to its former glory.
As a 401(k) investor, it's also wise to find out whose job it is to do the fund picking. Often, it's a hired hand in HR likely more schooled in recruitment than in investing.
4. "Our 'target-date funds' may miss the target."
In the wake of the Pension Protection Act passed this year, many 401(k)s will have "target date," or "life cycle," funds as their default option. These funds devise an asset allocation based on when you think you'll retire and become more conservative as that date nears. Target-date funds address one of the worst mistakes 401(k) investors make: keeping all their savings in low-return investments like money markets or stable-value funds that won't produce enough for retirement.
But research shows some target-date funds may come up short. The problem, says Tom Fontaine, a senior portfolio manager at AllianceBernstein, is that even these funds may become too conservative too early. "You need more equity than conventional wisdom suggests," he says. Stocks may be volatile in the short term, but without them, you risk running out of money in retirement. By his estimates, even a 50-year-old needs the majority of his portfolio in stock, as well as more diversification think REITs, international investments and inflation-protected securities. Target-date funds are still helpful, but they're not the panacea your provider might suggest they are...yet.
5. "We offer tons of investment options. Too many, in fact..."
When it comes to picking funds for your 401(k), the more choices the better, right? Wrong. The latest survey from the Profit Sharing/401(k) Council of America shows that, on average, 401(k) investors have 19 fund options, but with more than 10 to 12, "the average participant goes into paralysis," says Rick Meigs at 401khelpcenter.com. Indeed, academic research draws a direct link between "choice overload" and poor investment decisions: For every 10 funds added to a plan, the probability participants will invest nothing in stock funds goes up significantly. The result: cash- or bond-heavy portfolios unlikely to yield enough for retirement.
According to Emir Kamenica, assistant professor of economics at the University of Chicago Graduate School of Business and coauthor of the study, there is no magic number. Instead, he suggests that plans offer a handful of core funds including a money market, bond index, domestic equity index and international equity index, with extra choices for those who want them. "Nobody will be worse off by allowing investors who are more sophisticated to select from a wider range of options," Kamenica says.
6. "...but you still aren't diversified."
The two most popular holdings in 401(k)s are stable-value funds and company stock, says Pam Hess, senior retirement consultant at Hewitt Associates. And "neither is appropriate." Stable-value funds protect your savings but, by design, don't take enough risk to create as much return as bond or stock funds. Young workers in particular should not have big chunks of their 401(k)s in them. As for company stock, many planners will tell you not to put any of your retirement money there.Your company pays your salary and provides health benefits, so you already have enough exposure. What's more, you never want the bulk of your portfolio in one stock. But despite watching companies like Enron crumble, employees with 401(k) plans still put 22% of their holdings in company stock, on average, and one in five participants holds more than half of his balance there.
If part of your 401(k) match is in company stock, sell it; it should never compose more than 10% of your portfolio. A target-date fund or mix of large- and small-cap equity, international investments and fixed income is a wiser way to go, Hess says.
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2. "You're buying wholesale, but we're charging you retail."
With $2.4 trillion sloshing around in 401(k) plans, you shouldn't be paying the same fees for a fund that you would if, say, you bought it on your own. But in reality, you might be. Here's how it works: Asset managers sell mutual funds in different share classes, each of which has a different fee structure. From the most expensive to the cheapest class of funds, the range can be as much as a full percentage point, says Yannis Koumantaros, chief pension consultant at Spectrum Pension Consultants. That works out to an extra $1,200 a month in retirement for a 30-year-old with $50,000 in his plan and contributions of $3,000 annually. "You're talking about a difference in your quality of life at retirement," Koumantaros says.
What plans have the highest fees? Usually, those with the fewest investors. Small plans are expensive to run, so they often have to accept costlier fund classes. But your employer can renegotiate for cheaper options as the plan expands: Those holding between $10 million and $30 million per asset class should lobby for institutional funds, which are cheaper on average than traditional mutual funds.
3. "No one in his right mind would buy these funds given a choice."
Confused about why your 401(k) doesn't offer the top funds? That's because your asset manager may not have them in each category it might offer stellar large-cap stock funds but mediocre small-cap picks. And providers may charge extra for better alternatives from other sources. "If you see some lousy funds from the company that's providing the plan, that's probably why," says Russel Kinnel, research director at Morningstar. Another issue: Funds need to be big enough that they don't get swamped by the influx of 401(k) money, but for mutual funds, size is often a handicap. Take Fidelity's Magellan, the poster child for asset bloat. The fund is a mainstay of 401(k)s, but has underperformed the S&P 500 for years. It closed to new retail investors in 1997 but continuesto accept new 401(k) money. The current manager has revamped the strategy, but only time will tell if Magellan can return to its former glory.
As a 401(k) investor, it's also wise to find out whose job it is to do the fund picking. Often, it's a hired hand in HR likely more schooled in recruitment than in investing.
4. "Our 'target-date funds' may miss the target."
In the wake of the Pension Protection Act passed this year, many 401(k)s will have "target date," or "life cycle," funds as their default option. These funds devise an asset allocation based on when you think you'll retire and become more conservative as that date nears. Target-date funds address one of the worst mistakes 401(k) investors make: keeping all their savings in low-return investments like money markets or stable-value funds that won't produce enough for retirement.
But research shows some target-date funds may come up short. The problem, says Tom Fontaine, a senior portfolio manager at AllianceBernstein, is that even these funds may become too conservative too early. "You need more equity than conventional wisdom suggests," he says. Stocks may be volatile in the short term, but without them, you risk running out of money in retirement. By his estimates, even a 50-year-old needs the majority of his portfolio in stock, as well as more diversification think REITs, international investments and inflation-protected securities. Target-date funds are still helpful, but they're not the panacea your provider might suggest they are...yet.
5. "We offer tons of investment options. Too many, in fact..."
When it comes to picking funds for your 401(k), the more choices the better, right? Wrong. The latest survey from the Profit Sharing/401(k) Council of America shows that, on average, 401(k) investors have 19 fund options, but with more than 10 to 12, "the average participant goes into paralysis," says Rick Meigs at 401khelpcenter.com. Indeed, academic research draws a direct link between "choice overload" and poor investment decisions: For every 10 funds added to a plan, the probability participants will invest nothing in stock funds goes up significantly. The result: cash- or bond-heavy portfolios unlikely to yield enough for retirement.
According to Emir Kamenica, assistant professor of economics at the University of Chicago Graduate School of Business and coauthor of the study, there is no magic number. Instead, he suggests that plans offer a handful of core funds including a money market, bond index, domestic equity index and international equity index, with extra choices for those who want them. "Nobody will be worse off by allowing investors who are more sophisticated to select from a wider range of options," Kamenica says.
6. "...but you still aren't diversified."
The two most popular holdings in 401(k)s are stable-value funds and company stock, says Pam Hess, senior retirement consultant at Hewitt Associates. And "neither is appropriate." Stable-value funds protect your savings but, by design, don't take enough risk to create as much return as bond or stock funds. Young workers in particular should not have big chunks of their 401(k)s in them. As for company stock, many planners will tell you not to put any of your retirement money there.Your company pays your salary and provides health benefits, so you already have enough exposure. What's more, you never want the bulk of your portfolio in one stock. But despite watching companies like Enron crumble, employees with 401(k) plans still put 22% of their holdings in company stock, on average, and one in five participants holds more than half of his balance there.
If part of your 401(k) match is in company stock, sell it; it should never compose more than 10% of your portfolio. A target-date fund or mix of large- and small-cap equity, international investments and fixed income is a wiser way to go, Hess says.
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