Objective information about financial planning, investments, and retirement plans

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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1% a Small Number with Big Implications

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Percent Symbols - Best Percentage Growth or In...

The inspiration for this post comes from fellow finance blogger and financial advisor Jim Blankenship and his November is “Add 1% to Your Savings Month” movement.

It’s amazing how a small number like 1% can have such a big impact on your investments and the amount you’ll be able to accumulate for goals like retirement.  Here is a look at the impact of saving 1% on your investment expenses.

Mutual fund expenses matter

Using two share classes of the American Funds EuroPacific Growth fund as an example, the chart below illustrates the impact of 1% in expenses on the growth of your investment.  I was able to find two share classes of this fund whose expense ratios were exactly 1% different.  The B shares (ticker AEGBX) carry an expense ratio of 1.59% and the F-2 shares (ticker AEPFX) which carry and expense ratio of 0.59%.  Using Morningstar’s Advisor Workstation I compared the growth of a hypothetical $10,000 investment in each fund held over three time periods.

5 years ending 10/31/13 

Value of $10,000 investment
B Shares $17,710
F-2 Shares $18,606

 

As you can see varying nothing more than the expense ratio in these otherwise identical mutual funds, investing in the fund with a 1% lower expense ratio resulted in the accumulation of an additional $896 a 5.1% increase over an investment in the B share class.

10 years ending 10/31/13

Value of $10,000 investment
B Shares $22,677
F-2 Shares $24,734

 

Again varying nothing more than the expense ratio in these otherwise identical mutual funds, investing in the fund with a 1% lower expense ratio resulted in the accumulation of an additional $2,057 a 9.1% increase over an investment in the B share class.

From 4/30/84 through 10/31/13 

Value of $10,000 investment
B Shares $205,652
F-2 Shares $260,042

 

Once again varying nothing more than the expense ratio in these otherwise identical mutual funds, investing in the fund with a 1% lower expense ratio resulted in the accumulation of an additional $54,390 a 26.4% increase over an investment in the B share class.

A couple of things about the above comparison:  The assumption is that an investor put $10,000 into each of the funds and held them for the full time period, including the reinvestment of all fund distributions.  Any potential taxes or the expenses of engaging an investment advisor were not considered.  Further B shares are no longer available to new investors and even when they were they would generally convert to the less expensive A shares after a period of time.  None the less this comparison illustrates the impact saving 1% on your investment expenses can have on your returns and the amount you can potentially accumulate over time. 

How to reduce investing expenses 

While you may not always be able to save a full 1%, reducing your investment expenses by even a fraction of 1% can have a significant positive impact.  Here are some ideas that may help:

  • Utilize low cost index mutual funds and ETFs where possible and where they fit your investment strategy.  In many asset classes index funds outperform the majority of actively managed products.  Combine this with low expenses and index funds have a major leg up on most of their competitors.
  • In all cases make sure that you invest in the lowest cost share class of a given mutual fund that is available to you.
  • Avoid sales loads whenever possible.
  • Understand the expenses associated with the investment choices in your company’s 401(k) plan and the plan’s overall expenses.  If they are excessive consider asking your company’s plan administrator to look at some lower cost alternatives.  You might also  consider limiting your contributions to the amount needed to receive the maximum company match (if one is offered) and invest the remainder of your retirement savings elsewhere.
  • If you work with a financial advisor you must fully understand all of the ways in which your advisor makes money from your relationship.  This might include fees (hourly, flat-fee, or a percentage of assets).  In some cases the advisor makes money from the investment and insurance products they sell to you.  This can include up-front sales commissions (loads), deferred loads (B shares which are mostly obsolete), and level loads (C shares).  Additionally the advisor may make money from trialing commissions (12b-1 fees) or surrender charges incurred if your sell out of some mutual funds or annuity products too early.  If you are a regular reader of this blog you know that I am horribly biased in favor of using fee-only advisors (of which and I am one), avoiding the inherent conflict of interest that can arise when an advisor earns money from the sale of financial products. 

Saving 1% might seem like a trivial endeavor, but as you can see it can have big ramifications for investors.

Please contact me at 847-506-9827 for a complimentary 30-minute consultation to discuss all of your financial planning and investing questions. Check out our Financial Planning and Investment Advice for Individuals page to learn more about our services.

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