Objective information about financial planning, investments, and retirement plans

Is the Dow Jones Industrial Average Still a Relevant Stock Market Index?

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The Dow Jones Industrial Average (DJIA) of 30 large stocks has long been arguably the most watched index for those following the stock market.  As I write this IBM a long-time index component reported a major miss in its quarterly earnings.

The stock was down some 7% for the day and due to this decline the DJIA was been down most of the day.  The index finished up some 19 points but without the drag of IBM the index would have been up around 100 points according to a commentator on CNBC.  This begs the question is the Dow Jones Industrial Average still a relevant stock market index?

It’s just 30 stocks 

The DJIA is a weighted average (the actual weighting formula is very complex) of the price of the 30 stocks that comprise the index.  Originally the index was supposed to represent the stocks of large industrial companies.  Over the years the composition of the index has changed to reflect the changing nature of American business.

Here are the 30 companies that comprise the index:

Company

 

 

 

 

 

3M Co
American Express Co
AT&T Inc
Boeing Co
Caterpillar Inc
Chevron Corp
Cisco Systems Inc
E I du Pont de Nemours and Co
Exxon Mobil Corp
General Electric Co
Goldman Sachs Group Inc
Home Depot Inc
Intel Corp
International Business Machines
Johnson & Johnson
JPMorgan Chase and Co
McDonald’s Corp
Merck & Co Inc
Microsoft Corp
Nike Inc
Pfizer Inc
Procter & Gamble Co
The Coca-Cola Co
Travelers Companies Inc
United Technologies Corp
UnitedHealth Group Inc
Verizon Communications Inc
Visa Inc
Wal-Mart Stores Inc
Walt Disney Co

 

Certainly a nice mix of manufacturers, retail, financial services, and technology related companies.  Three major names absent from the index include Google, Facebook, and Apple.  While these are large and influential companies they do not represent the total focus of the investment universe.

Chuck Jaffe wrote this excellent piece on the topic of the Dow It’s time to ditch the Dow Jones Industrial Average  over at the Market Watch site.

Investing options are varied and global 

Of the major market benchmarks the broader S&P 500 seems to hold a lot more sway with many money managers and others in the finance and investing world.  I know that personally I am a lot more concerned with this index as a benchmark for large cap mutual funds and ETFs than the Dow.

The NASDAQ is also widely watched due to its heavy tech influence.  I think the bursting of the Dot Com bubble put this index on the radar to stay back in early 2000.

Other key benchmarks include the Russell 2000 for small cap stocks, the Russell Mid Cap, the EAFE for large cap foreign stocks and many others for various market niches.  Additionally there are any number of index mutual funds and ETFs that follow these and other key benchmarks for those who want to invest in these segments of the stock market.

While I’m guessing the Dow will remain a widely watched and quoted stock market indicator I and many others find it increasingly irrelevant.  It is always a good idea to benchmark your investments against the appropriate index for a single holding or a blended, weighted benchmark to gauge your overall portfolio’s performance.

Five Things to do During a Stock Market Correction

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As you may or may not know the stock market has been going through some tough days recently.  For example the S&P 500 Index is down about 8% from its all-time high reached in September of this year.  While we are not officially in correction mode (this is usually defined as a 10% or greater drop in an index) there has been a lot of volatility lately.  Here are five things you should do during a stock market correction.

Do nothing

Assuming that you have a financial plan with an investment strategy in place there is really nothing to do at this point.  Ideally you’ve been rebalancing your portfolio along the way and your asset allocation is largely in line with your plan and your risk tolerance.  Making moves in reaction to a stock market correction (official or otherwise) is rarely a good idea.  At the very least wait until the dust settles.  As Aaron Rodgers told the fans in Green Bay after the Packers 1-2 start, relax.  They have since won three straight.  Sound advice for fans of the greatest team on the planet and investors as well.

Review your mutual fund holdings

I always look at rough market periods as a good time to take a look at the various mutual funds and ETFs in a portfolio.  What I’m looking for is how did they hold up compared to their peers during the market downturn.  For example during the 2008-2009 market debacle I looked at funds to see how they did in both the down market of 2008 and the up market of 2009.  If a fund did worse than the majority of its peers in 2008 I would expect to see better than average performance in the up market of 2009.  If there was under performance during both periods to me this was a huge red flag.

Don’t get caught up in the media hype

If you watch CNBC long enough you will find some expert to support just about any opinion about the stock market during any type of market situation.  This can be especially dangerous for investors who might already feel a sense of fear when the markets are tanking.  I’m not discounting the great information the media provides, but you need to take much of this with a grain of salt.  This is a good time to lean on your financial plan and your investment strategy and use these tools as a guide.

Focus on risk

Use stock market corrections and downturns to assess your portfolio’s risk and more importantly your risk tolerance.  Assess whether your portfolio has held up in line with your expectations.  If not perhaps you are taking more risk than you had planned.  Also assess your feelings about your portfolio’s performance.  If you find yourself feeling unduly fearful about what is going on perhaps it is time to revisit your allocation and your financial plan once things settle down.

Look for bargains

If you had your eye on a particular stock, ETF, or mutual fund before the market dropped perhaps this is the time to make an investment.  I don’t advocate market timing but buying a good long-term investment is even more attractive when it’s on sale so to speak.

Markets will always correct at some point.  Smart investors factor this into their plans and don’t overreact.  Be a smart investor.

5 Mutual Fund Investing Lessons from the Bill Gross Saga

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The soap opera at PIMco that began with the departure of Co-CEO Mohamed El-Erian in January came to a head with the recent departure of PIMco flounder Bill Gross.   More than just being the founder of PIMco Gross managed the firm’s flagship mutual fund PIMco Total Return (PTTRX).  His high profile exit once again brings one of the pitfalls of investing in actively managed mutual funds to the forefront.  Here are 5 mutual fund investing lessons from the Bill Gross saga.

Know who is in charge of your fund 

Bill Gross was the very public face of PIMco and was known as the “Bond King.”  To his credit he built PIMco Total Return into the world’s largest bond fund and the fund did very well for investors over the years.  The question investors, financial advisors, and institutions are now asking themselves is what is the future of the fund without Gross?

While PIMco promoted two very able managers to take over at Total Return, the redemptions that have plagued the fund over the past several years as a result of its downturn in performance have continued and seem to be accelerating in the short-term.  Much of this I’m sure stems from the uncertainty over the direction of the fund under these new managers.

Succession planning is vital

While most fund manager changes don’t take place in this fashion if you invest in a mutual fund run by a superstar manager what happens if he or she leaves?  For example does Fidelity have a plan to replace Will Danoff when he decides to leave Fidelity Contra (FCNTX)?

One of the long-time co-managers of Oakmark Equity-Income (OAKBX) retired a couple of years ago.  This was planned and announced ahead of time.  Shortly after that the fund brought on four younger co-managers to help the remaining long-tenured manager manage the fund and more importantly to provide succession and continuity for the fund’s shareholders.

The investment process matters 

What makes an actively managed mutual fund unique is its investment process.  If the fund were to merely mimic its underlying index why not just invest in a low cost, passively managed index fund?  There have been a number of articles in the financial press in recent years discussing “closet index” funds.  These are actively managed funds that for all intents and purposes look much like their underlying benchmark.  This is fairly prevalent in the large cap arena with many funds mimicking the S&P 500.  Why invest in an actively managed fund that is really nothing more than an overpriced index fund?

An institutionalized investment process is key when a manager leaves a fund.  I can think of three small cap funds I’ve used over the years that transitioned to new managers seamlessly via the use of a solid investment process.  While it is expected that the new managers may make some changes over time, I’ve also seen well-known funds replace a superstar manager and essentially have the new manager start over.  The results are too often not what shareholders have come to expect.  To a point this is what has happened to Fidelity’s one-time flagship fund Magellan since the legendary Peter Lynch left a number of years ago.  Subsequent managers have never been able to come close to replicating the fund’s former lofty position.

Even the best managers have down periods 

Bill Gross has made a lot of money for shareholders in PIMco Total Return and other funds he managed over time.  However Total Return has lagged its peers over the past several years which has led to a lot of money flowing out of the fund and the firm in recent years.  It is not uncommon for a top manager to go through a few down years over the course of a solid long-term run.  The trick is to be able to determine if this is a temporary thing, or if this manager’s best days are in the past.  For example if the fund has grown to be too large the manager may have more money to manage than he or she can effectively invest.

Is an index fund a better alternative? 

To be clear I am not in the camp that indexing is the only way to go when investing.  There are a number of very good active managers out there, the trick is to be able to identify them and to understand what makes their strategy and investment process successful.

However before ever investing in an actively managed mutual fund, ask yourself what will I be gaining over investing in an index mutual fund or ETF?

It was sad for me to see Gross’ tenure at PIMco end as it did.  It is not always easy to go out on top.  Michael Jordan should have quit after sinking the winning shot to secure the Chicago Bulls’ last championship.  Perhaps the role model here is the late Al McGuire whose last game as the men’s basketball coach at Marquette ended with the Warriors winning the 1977 NCAA championship.

For more on Bill Gross and PIMco please check out my two most recent articles for Investopedia:   What To Expect From Pimco After Bill Gross and Pimco Investor? Consider This Before Bailing.  

Please check out our Book Store for books on financial planning, retirement, and related topics as well as any Amazon shopping needs you may have (or just click on the link below).  The Chicago Financial Planner is a participant in the Amazon Services LLC Associates Program, an affiliate advertising program designed to provide a means for sites to earn advertising fees by advertising and linking to Amazon.com.  If you click on my Amazon.com links and buy anything, even something other than the product advertised, I earn a small fee, yet you don’t pay any extra. 

Your 401(k) – A To Do List for the Rest of 2014

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In a recent post Eight Financial To Do Items for the Rest of 2014, I outlined several items for your financial to do list for the rest of 2014.  One of those items was to review your 401(k) plan.  Here are a few more steps to take with your 401(k) plan yet this year.

Review your salary deferral amount

The maximum dollar amount that you can defer from your salary is $17,500 or $23,000 if you are 50 or over at any point during 2014.  If you are not on track to max out your contributions now is a good time to see if you can increase your salary deferral percentage even by 1%.  In the long run this will put you that much farther ahead in your question to build a retirement nest egg.

Review and if needed rebalance your account

Both the S&P 500 and the Dow Jones Industrial Average have hit a number of new record highs during 2014 on the heels of a very solid 2013.  In fact the S&P 500 Index is up almost threefold since the market lows of March, 2009.  If you haven’t recently rebalanced the asset allocation of your account back to your target allocation this is an excellent time to do so.  Better still if your plan offers auto rebalancing this is a great time to sign up if you haven’t already.

Be aware of any changes to the plan

Fall is open enrollment time for employee benefits for many companies.  While changes to the level of your salary deferral contributions as well as to the investment choices you make can be done throughout the year, many companies choose this time frame to announce changes to their plan for the upcoming year.  This might include the level of the employer match, the addition of a Roth 401(k) feature, or changes to the menu of investment choices available to you.  You need to be aware of any and all changes to the plan and be ready to make any applicable adjustments based upon your situation.

Be cautious when it comes to company stock 

Perhaps as a sub-set of the rebalancing section mentioned earlier if your account includes an investment in your company’s stock this is a good time to review how much you have allocated there and if needed pare that amount down.  There are no hard and fast rules but many financial advisors suggest keeping your allocation to company stock to 10% or less.  The rational here is that you already depend upon your employer for your livelihood; if the company runs into problems you might find yourself unemployed and holding a lot of devalued company stock in your retirement plan.

Get a handle on any old 401(k) accounts 

It’s not uncommon for folks to have several old 401(k) accounts from former employers.  It’s also not uncommon for these accounts to be neglected and unwatched.  If this describes you make this the year to get your arms around these accounts and make some decisions.  Roll them over to an IRA or if eligible to your current 401(k) plan.  If leaving one or more of them with that former employer is a good decision make sure you monitor the account, rebalance when needed, etc.  The point is even if these accounts are relatively small they can add up and help as you save for retirement.  Take charge and take affirmative action here.

Understand your options should you leave your current employer 

Let’s face it the last part of the year is often when companies do layoffs.  If you suspect that you will be impacted in this way you should at least start thinking about what you will do with your 401(k) account.  The same holds true if you are looking for a new job or considering going out on your own.

As we head into football season, the kid’s activities at school, and the holidays please make some time to tend to these and perhaps other items in connection with your 401(k) plan.  For many of us our 401(k) is our primary retirement savings vehicle, make sure that it is working hard for you.

Please check out our Book Store for books on financial planning, retirement, and related topics as well as any Amazon shopping needs you may have (or just click on the link below).  The Chicago Financial Planner is a participant in the Amazon Services LLC Associates Program, an affiliate advertising program designed to provide a means for sites to earn advertising fees by advertising and linking to Amazon.com.  If you click on my Amazon.com links and buy anything, even something other than the product advertised, I earn a small fee, yet you don’t pay any extra. 

The Plutus Awards – Finance Blogs to Read and Discover

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The finalists for the 2014 Plutus Awards which celebrates the best in personal finance blogging were recently announced.  Check out the official announcement here.  I was very honored and flattered to have this blog named as a finalist in the Best Financial Planner Blog category.

What is most gratifying is that the finalists were chosen by other finance bloggers.  I am humbled by and grateful for being selected as a finalist among all of these outstanding finance blogs.  I read many of them and plan to check out the ones that I am not familiar with.

If you are looking for a list of finance blogs to read and learn from here is list of the finalists by category:

Best New Personal Finance Blog

FITnancials
Listen, Money Matters!
Rock Star Finance
Stapler Confessions
ValerieRind.com

Best-Kept Secret Personal Finance Blog

Debt Discipline
Free From Broke
L Bee and the Money Tree
The Frugal Exerciser
Wealthy Single Mommy

Best Designed Personal Finance Blog

Be Wealthy & Smart
Budget Blonde
Christian PF
Financially Blonde
Good Financial Cents

Most Humorous Personal Finance Blog

The Empowered Dollar
Financial Uproar
Frugalwoods
Len Penzo dot Com
Punch Debt in the Face

Best Microblog

@JimYih
@MMarquit
@MoneyCrashers
@rockstarfinance
@wisebread

Best Personal Finance Podcast

Cash Car Convert
Dough Roller
Listen Money Matters
Money Plan SOS
Stacking Benjamins

Best Retirement Blog

Escaping Dodge
Financial Mentor
Mr. Money Mustache
Retire by 40
Retire Happy

Best Entrepreneurship Blog

Beat the 9 to 5
Careful Cents
Create Hype
Microblogger
My Wife Quit Her Job

Best Blog for Teens/College Students/Young Adults

Broke Millennial
Making Sense of Cents
TeensGotCents
The Broke and Beautiful Life
Young Adult Money

Best International Personal Finance Blog

Monster Piggy Bank
Reach Financial Independence
The Skint Dad Blog
The Money Principle
Miss Thrifty

Best Canadian Personal Finance Blog

Blonde on a Budget
Boomer & Echo
Canadian Budget Binder
Canadian Finance Blog
Money after Graduation

Best Religious Personal Finance Blog

Bible Money Matters
Christian PF
Indebted and in Debt
Luke1428
Out of Your Rut

Best Tax Blog

The Blunt Bean Counter
Tax Girl
JoeTaxpayer
TaxProfBlog
The Wandering Tax Pro

Best Deals and Bargains Blog

$5 Dinners
Bargain Babe
Bargain Briana
CouponMom
Hip2Save

Best Frugality Blog

Club Thrifty
Frugal Rules
I Am That Lady
Pretty Frugal Living
Stapler Confessions

Best Debt Blog

Dear Debt
Debt Roundup
Enemy of Debt
Money Plan SOS
The Frugal Farmer

Best Investing Blog

Dividend Mantra
Financial Mentor
Investor Junkie
Personal Dividends
The College Investor

Best Contributor/Freelancer for Personal Finance

Cat Alford
Jason Steele
Michelle Schroeder
Miranda Marquit
Stefanie O’Connell

Best Green/Sustainability Blog

DIY Natural
Prairie Eco-Thrifter
Sustainable Life Blog
Sustainable Personal Finance
The Frugal Farmer

Best Financial Planner Blog

Financially Blonde
Good Financial Cents
Nerd’s Eye View
Mom and Dad Money
The Chicago Financial Planner

Lifetime Achievement

FMF (Free Money Finance )
FrugalTrader (Million Dollar Journey)
Jim Wang (Bargaineering)
Lazy Man (Lazy Man And Money)
Ramit Sethi (I Will Teach You To Be Rich)

BLOG OF THE YEAR

Afford Anything
Broke Millennial
Canadian Finance Blog
The Empowered Dollar
Making Sense of Cents
Mr. Money Mustache
PT Money
Stacking Benjamins
Wealthy Single Mommy
Wise Bread

Congratulations to all of the finalists.  Note I did leave off a couple of categories that were mostly internal blogging resources.

There is plenty of excellent personal finance information contained in the list above, time to get reading.

Please check out our Book Store for books on financial planning, retirement, and related topics as well as any Amazon shopping needs you may have (or just click on the link below).  The Chicago Financial Planner is a participant in the Amazon Services LLC Associates Program, an affiliate advertising program designed to provide a means for sites to earn advertising fees by advertising and linking to Amazon.com.  If you click on my Amazon.com links and buy anything, even something other than the product advertised, I earn a small fee, yet you don’t pay any extra. 

Pension Payments – Annuity or Lump-Sum?

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I’m often asked by folks approaching retirement whether to take their pension as a lump-sum payment or as an annuity (a stream of monthly payments).  Investment News recently published this excellent piece on this topic which is worth reading.

As with much in the realm of financial planning the answer is that “it depends.”  Everybody’s situation is different.  Here are some factors to consider in deciding whether to take your pension payments as an annuity or as a lump-sum.

Factors to consider 

Among the factors to consider in determining whether to take your pension payments as an annuity or as a lump-sum are: 

  • What other retirement assets do you have?  These might include:
    • IRA accounts
    • 401(k) or 403(b) accounts
    • Taxable investments such as stocks, bonds, mutual funds, or others
    • Cash and CDs
  • Will you be eligible for Social Security?
  • Will the monthly pension payments be fixed or will they include cost of living increases?
  • Are you comfortable managing a lump-sum yourself and/or do you have a trusted financial advisor to help you?
  • What are your expectations for future inflation? 
  • What is your current tax situation and what are your expectations for the future?

Factors that favor taking payments as an annuity 

An annuity might be the right option for you if:

  • You have sufficient other retirement resources and are seeking to diversify your sources of income during retirement.
  • You are uncomfortable with managing a large lump sum distribution.
  • You are not eligible for Social Security.
  • Your pension payments have potential cost of living increases built-in (typical for public sector plans but not for private pensions).

Factors that favor taking payments as a lump-sum 

A lump-sum distribution might be the right option for you if:

  • You are comfortable managing your own investments and/or work with a financial advisor with whom you are comfortable.
  • You have doubts about the future solvency of the organization offering the pension.  This pertains to both a public entity (can you say Detroit?) and to a for-profit company.  In the latter case pension payments are guaranteed up to certain monthly limits set by the PBGC.  If you were a high-earner and your monthly payment exceeds this limit you could see your monthly payment reduced.
  • You are eligible for Social Security payments. 

The factors listed above favoring either the annuity or lump-sum options are not meant to be complete lists, but rather are intended to stimulate your thinking if you are fortunate enough to have a pension plan and the plan offers both payment options.  A full listing for each option would be much longer and might vary based upon your unique situation.

Moreover the decision as to how to take your pension payments should be made in the overall context of your retirement and financial planning efforts.  How does each payment method fit?

Lastly those evaluating these options should be aware of predatory financial advisors seeking to convince retirees from major corporations and other large organizations to roll their retirement plan distributions over to IRA accounts with their firm.  While this issue has seen a lot of recent press in terms of 401(k) plans it is also an issue for those eligible for a lump-sum pension distribution. If you are working with a trusted financial advisor an IRA rollover can be a viable option, but in some cases rollovers have been directed to questionable investment options putting many retirement investors at risk.

Please check out our Book Store for books on financial planning, retirement, and related topics as well as any Amazon shopping needs you may have (or just click on the link below).  The Chicago Financial Planner is a participant in the Amazon Services LLC Associates Program, an affiliate advertising program designed to provide a means for sites to earn advertising fees by advertising and linking to Amazon.com.  If you click on my Amazon.com links and buy anything, even something other than the product advertised, I earn a small fee, yet you don’t pay any extra. 

3 Misunderstood Aspects of Social Security Benefits

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This post was written by Jim Blankenship, CFP®, EA, a fee-only financial advisor and owner of the excellent finance blog Getting Your Financial Ducks in a Row, where he covers IRAs, Social Security, Taxation, and most other aspects of financial planning.  I’ve known Jim for a long time and consider him an expert on Social Security and many other topics.  His blog is must-reading for me and should be for you as well.

The Social Security benefit landscape is a complicated and confusing place to navigate. It’s tough enough to figure out what is the best time to file for your own benefits, let alone trying to coordinate benefits for yourself and your spouse.  There are many confusing provisions of Social Security; below is a brief explanation of 3 misunderstood aspects of Social Security benefits.

Spousal benefits

When one spouse is eligible for retirement benefits, the other spouse is also eligible for a benefit based upon the first spouse’s record.  The largest Spousal Benefit is 50% of the other spouse’s Primary Insurance Amount (PIA).  The PIA is equal to that individual’s benefit available at Full Retirement Age (FRA). Full Retirement Age is 66 for folks born between 1946 and 1954, increasing to age 67 for those born in 1960 or after.

An individual may receive the Spousal Benefit as early as age 62, at a reduced rate. The other spouse must have filed for his or her own benefit – and could have suspended benefits (see File and Suspend below).

The confusing parts. The following areas always seem to trip up folks as they plan for the Spousal Benefit.

  1.  Only one of the spouses can receive Spousal Benefits at a time. The other spouse must have filed or filed and suspended for his or her own benefit.
  2.  At or after FRA, the individual can receive Spousal Benefits alone, separate from the retirement benefit on his or her own record (see Restricted Application below).  This allows the spouse receiving Spousal Benefits to delay receiving his or her own benefit, increasing that retirement benefit (via Delayed Retirement Credits).
  3.  Before FRA, filing for Spousal Benefits will result in a reduced Spousal Benefit. Plus, filing for Spousal Benefits before FRA will result in deemed filing for the individual’s own retirement benefit, with both benefits reduced. 

File and Suspend

When the individual who is eligible for a retirement Social Security benefit reaches Full Retirement Age (FRA), the individual may voluntarily suspend receiving benefits.  By suspending benefits, the individual has accomplished two things:

  1.  The individual has established a filing date for benefits. This means that the Social Security Administration has a record that the individual has filed for benefits. Since that record exists, other benefits become available based upon the individual’s Social Security record. Also, at some point in the future, the individual could change his or her mind and collect retroactive benefits from the established filing date to the present, continuing to receive monthly benefits as if the filing was never suspended.
  2. The individual will not receive benefits while the suspension is in place. If the individual does not collect retroactive benefits at a later date (see #1 above), Delayed Retirement Credits will add to his or her future benefit. This amounts to an 8% increase in benefits per year of delay.

Restricted Application 

As mentioned above, when an individual reaches Full Retirement Age (FRA) and is eligible for a Spousal Benefit, the individual may choose to file a Restricted Application for Spousal Benefits only.  This type of application provides for the individual to receive *only* the Spousal Benefit, based upon his or her spouse’s record. By doing so, he or she can delay filing for his or her own benefit to a later date.  With the delay, the individual’s own benefit will gain Delayed Retirement Credits; maximizing the benefit by age 70.

Jim Blankenship, CFP®, EA, is a fee-only financial advisor.  Check out his blog Getting Your Financial Ducks in a Row, follow him on Google+ and Facebook as well.  

Please check out our Book Store for books on financial planning, retirement, and related topics as well as any Amazon shopping needs you may have (or just click on the link below).  The Chicago Financial Planner is a participant in the Amazon Services LLC Associates Program, an affiliate advertising program designed to provide a means for sites to earn advertising fees by advertising and linking to Amazon.com.  If you click on my Amazon.com links and buy anything, even something other than the product advertised, I earn a small fee, yet you don’t pay any extra. 

6 Signs of a Good 401(k) Plan

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Much has been written about lousy 401(k) plans, and rightly so there are a lot of them out there.  But what does a good 401(k) plan look like?  Here are 6 signs of a good 401(k) plan.

    • Reasonable administrative expenses.
    • An investment menu that contains solid, low-cost choices, including index fund alternatives.
    • An investment committee or similar group that monitors the plan’s investments and manages the plan in accordance with an investment policy statement.
    • An investment line-up that includes some sort of a managed option for participants who are uncomfortable managing their investments. This might be Target Date Funds, or even access to direct advice.
    • The investment line-up contains choices across a wide range of asset classes.
    • The investment menu isn’t stuffed with proprietary mutual funds or a majority of choices from a single fund family. 

A few thoughts on several of these items: 

Reasonable administrative expenses 

Frankly this will be difficult for most 401(k) participants to gauge.  Depending upon how your plan is structured via your company and the plan provider all of the costs to administer the plan may be covered by the expense ratios of the mutual funds (or other investment options) offered via revenue sharing or similar arrangements.

The expenses paid out of plan assets (your account balance)  over and above what might be covered by the expense ratios of the mutual funds offered will be listed on your quarterly account statements as part of the required fee disclosures that also include separate disclosures pertaining to the plan’s investments.  They may be a bit cryptic and are usually listed as one or several line items on the statement.

To approximate what you are paying in total (including admin expenses) you will need to take a weighted average of the fund expense ratios for the investment options you hold plus these expenses listed on your statement (double check to see if these are annual or quarterly) and divide the total into your balance.

Don’t take this as a hard and fast benchmark, but anything over 1% I would consider high as many plans I have dealt with are far lower all-in.

One way to gauge where your plan falls is to check the BrightScope site and type your company’s or plan’s name in the retirement plan search are on the top right of the site.  You’ll note that if your plan is rated there will be several rankings including plan cost.  Note there is a drop down box where you can compare your plan to both all plans and also to plans in a similar size range.  This ranking is a helpful tool as a starting point. 

Low cost investment choices 

While low costs don’t guarantee good investment returns, low mutual fund expenses have been shown to be a predictor of better investment returns.

Index funds are often cited as a solid low cost investment option and for the most part this is true.  Index funds are also generally true to their investment style and in many cases out perform a high percentage of actively managed funds.

Low cost also pertains to offering the lowest cost share class available to the plan in the case of mutual funds.  Examples of low cost share classes include:

  • Fidelity’s K share class
  • Institutional (applies to many fund families)
  • Vanguard Admiral or Signal shares (the latter will be phased out and converted to Admiral shares)
  • American Funds R6
  • T. Rowe Price (not the R or Adv share classes) 

Additionally many large employers are able to offer ultra-low cost institutional options via their plan provider.

Target Date Funds and managed options 

Target Date Funds are a huge growth area for mutual fund providers since the Pension Protection Act of 2006 made them a Qualified Default Investment Alternative (QDIA).  In plain English this means that plan sponsors can direct the salary deferrals of participants who do not make an affirmative investment election into the Target Date Fund closest to their projected retirement age.  Fidelity, Vanguard, and T. Rowe Price collectively have 70% or more of the total Target Date Fund assets.

Some plans might offer risk-based accounts that invest in a static asset mix as opposed to the Target Date Funds that will reduce their allocation to stocks as the fund moves closer to its target date.  At some point the Target Date Fund will move to a glide path which is a fixed allocation to equity that the fund maintains at some point which will vary widely by fund family.

Some plans may offer access to professional management of your account.  Typically there would be some sort of fee (often charged as a percentage of the assets in your account).  In some cases the plan provider such as Vanguard, Fidelity, or others might offer this service and in other cases it might be an external vendor such as Financial Engines.

I view the availability of any or all of the above options as a positive, but I also urge plan participants to fully understand what they are investing in in terms of Target Date Funds or risk-based options.  This also applies to any professional management services as well.  Just like choosing a financial advisor of any type you need to fully understand how they are allocating your money, do they consider outside investments in making their recommendations, and are they a fiduciary. 

The investment menu 

A well-rounded investment menu should include options covering a number of domestic and international equity styles, bonds, and fixed income, as well as a cash option (typically a money market fund or a stable value fund).  In addition other asset classes such as real estate, commodities, and others could be offered depending upon demographics of the participants and the desires of the plan sponsor.

As indicated above managed options are also a good idea.  In all cases it is important that the investments carry low expense ratios.

A menu of proprietary funds from the employer of the plan’s advisor or rep is generally not a good idea as these funds are often higher in cost.  Generally a plan comprised mostly or exclusively of mutual funds from a single firm should be frowned upon, even if the funds are all from excellent fund families like Vanguard or T. Rowe Price.  No one fund family offers the best options in every asset class.

An additional item that should be considered is the company match, if any.  Obviously the larger the match the better, The reason I did not list the match above is that a company can offer a decent match in an otherwise lousy plan.  In most cases it still makes sense to defer at least enough of your salary to earn the full match as this is essentially free money.

As far as an engaged investment committee or other involvement from the organization sponsoring the plan this is critical.  I’ve worked with excellent committees even in smaller organizations. The constant here is a group that wants to offer the best plan they can for their employees and is engaged in monitoring the plan a regular basis.  Often this is done in conjunction with an independent outside financial advisor.

The above is not meant to be an exhaustive description of a good 401(k) plan, but rather to highlight some of the signs of a good 401(k) plan that I’ve seen over the years.  What features do you look for in a 401(k) plan when deciding whether and how to invest?  Please feel free to leave a comment or to contact me directly.

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