Objective information about retirement, financial planning and investments

American Funds-The Secret Sauce for 401(k) Plans?

Share

Many registered reps selling 401(k) plans in the small to mid-sized market would have you believe this.

To be clear, I have enormous respect and admiration for American Funds as a fund family. They offer a number of excellent funds. They have a deep management/research group. I use several of their funds in 401(k) plan line-ups and in the accounts of some of my individual clients (no-load share classes).

Contrary to what these registered reps may tell you, an all American Funds lineup is not, in my opinion, a complete 401(k) solution.

  • There are no domestic small or mid cap funds in the American Funds line-up. These are typically core asset classes in a well-balanced plan lineup.
  • For 401(k) plans, the R class of shares is typically used. For smaller plans this might entail the R1 or R2 share classes, larger plans can use the much more reasonable R4 or R5 share classes.
  • For example looking at the Large Value Washington Mutual Fund
    • R1 expense ratio is 1.43% which includes a 12b-1 fee of 0.99%
    • R2 expense ratio is 1.50% which includes a 12b-1 fee of 0.75%
    • R3 expense ratio is 0.97% which includes a 12b-1 fee of 0.50%
    • R4 expense ratio is 0.69% which includes a 12b-1 fee of 0.25%
    • R5 expense ratio is 0.39% with no 12b-1 fee
  • In the case of most registered reps and commissioned brokers, the 12b-1 will go to compensate them for their involvement with the plan.
  • These expenses take their toll on the quality of the fund. Washington Mutual’s R1, R2, and R3 shares earned a score of 42 in the Fi360 ranking system as of 3/31/2010. This score is just in the top half of the peer group. By contrast the R4 shares earned a score of 23, which places this share class in the top quartile of its peer group. The R5 shares earned a score of 17.
  • Looking at this another way, the five year average annual return for the R1 shares is 0.47%; for the R5 shares it is 1.55%.

As a plan sponsor, if your advisor suggests going with an all American Funds line-up for your company’s 401(k) plan, you should ask many questions.

In the commissioned world, the American Funds represent one of the best fund families many of these reps can sell. As with other top-notch fund families such as T. Rowe Price and Vanguard, using a line-up consisting exclusively of any fund family is usually not a good idea and generally does not provide the best 401(k) line-up. This approach may be in your broker’s best interests, but as a 401(k) plan sponsor you need to do what is in the best interests of the participants in your company’s retirement plan.

Approaching retirement and want another opinion on where you stand? Not sure if your investments are right for your situation? Need help getting on track? Check out my Financial Review/Second Opinion for Individuals service for detailed guidance and advice about your situation.

NEW SERVICE – Financial Coaching. Check out this new service to see if its right for you. Financial coaching focuses on providing education and mentoring in two areas: the financial transition to retirement or small business financial coaching.

FINANCIAL WRITING. Check out my freelance financial writing services including my ghostwriting services for financial advisors.

Please contact me with any thoughts or suggestions about anything you’ve read here at The Chicago Financial Planner. Don’t miss any future posts, please subscribe via email. Check out our resources page for links to some other great sites and some outstanding products that you might find useful.

 

 

Enhanced by Zemanta

Don't miss another post, subscribe via email

If you enjoyed this article, please enter your email address to receive the latest updates about financial planning, investments, and retirement plans.

Comments

  1. Great post, Roger, and an important message.

    I've met many advisors over the years for whom American Funds (or another single product vendor) is their solution to anything, anytime and anywhere.

    Many consumers have been well served by American Funds over the years — I agree with you — but a one-size-fits-all approach to planning and investment management is hardly adequate for making sure the client is making the most of their wealth, and more importantly — their life.

  2. Russ thanks for your comment, well said.

  3. Roger-

    Your post also has implications for target date funds. The vast majority of TDF's are all proprietary funds, which begs the question of whether a single fund family can offer top quality funds in each asset class. Your post would suggest that they cannot, and I think many others would agree. Yet in spite of this, proprietary target date funds are the fastest growing segment of funds in the retirement space . . .

    -Ryan Alfred, BrightScope

  4. I agree with Russ and you Roger on this. Limiting plan participants to one fund company is not doing them any favors. Using higher expense ratio funds reduces the retiree's retirement resources in favor of the broker's ultimate retirement resources.

  5. Ryan I think you make a great point. Even the best of the TDFs generally have this issue. I would have thought by this time there would be a number of "next generation" TDFs who took funds from a variety of families to construct the best fund possible. This is a good argument for custom TDFs or Lifestyle funds managed by the plan's advisor.

    Sam thanks for your comment and your point is right on. Unfortunately I see this too often in small plans either via the American Funds route or via a high cost, low quality bundled insurance group annuity vehicle. In the end the participants get the short end while the broker pockets a nice commission for doing nothing.

  6. Ron Rhoades says

    Good post, Roger. While I respect American Funds as a fund family, they tend to have higher transaction costs than I would like. In part this is because they pay soft dollar compensation (i.e., higher commissions to brokers, in return for “research,” for securities trades within the fund), and portfolio turnover tends to be a bit high. Also, cash holdings as a percentage of fund assets can lead to high opportunity costs. Additionally, payment for shelf space arrangements (i.e., payments by the investment adviser of the fund, to broker-dealers) exist, which money could be utilized instead to lower investment advisory fees. Hence, when I have examined them for possible use, the higher “total fees and costs” of these funds fail my screens.

    • Roger Wohlner says

      Ron thanks for the comment and I generally agree with your assessment. I use the EuroPacific fund the most out of this family and then almost exclusively in a couple of 401(k) plans. We have been able in one case to get into the R6 shares which carries a very low expense ratio of 0.50% given that it is an activley managed Foreign Large Blend fund. Still working to move the other plan to that share class as well. Overall in my opinion this fund is a solid core foreign stock holding.

      What prompted me to write this post originally was the frustration with seeing so many smaller plans sold by registered reps and commissioned types that had a line-up of all American Funds and as often as not were in very pricey R1 or R2 shares. There is no single fund family that I could ever justify offering exclusively to plan participants. The overall cost of these plans is a real drain on the ability of the participants to accumulate a sufficient amount for retirement. Hopefully the new era of fee disclosure will put a damper on these types of plans.

Trackbacks

  1. […] 401(k) Fee Disclosure and the American Funds By Roger Wohlner on July 9, 2012 | Leave a response About two years ago I wrote what remains one of the most popular posts on this blog American Funds-The Secret Sauce […]

  2. […] for use in 401(k) plans.  The most robust menu of retirement plan share classes belongs to the American Funds.  Continuing with the American Funds Washington Mutual example, there are 6 retirement plan share […]

Speak Your Mind

*

This site uses Akismet to reduce spam. Learn how your comment data is processed.