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The Risks of Too Much Company Stock in Your 401(k) Plan

August 21, 2015 by 4 Comments
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Retirement plan sponsors are starting to get it, requiring 401(k) participants to hold company stock in their accounts exposes them to major fiduciary liability if the stock price tanks. That said it is still an option in many 401(k) plans.

According to Fidelity about 15 million people own about $400 billion in company stock across 401(k) plans that they administer.

Too dependent on your employer    

Just ask former employees of Enron, Lehman Brothers or Radio Shack about this.

All employees depend on their employer for a paycheck. If you add a high level of company stock as a component of your 401(k) account you have a recipe for disaster. If the company tanks you might find yourself out of job with no income. If this difficulty causes the stock price to decline you are not only unemployed but your retirement nest egg has taken a hit as well.

How much is too much? 

There is no one right answer; this will vary on a case by case basis. Many financial advisors say the total in employer stock should be kept to a maximum of 5% to 10% of total investment assets. This not only includes stock held in your retirement plan but also shares held outside the plan as well shares represented by any stock options or restricted shares that may be held.

Employers and fiduciary risk 

In the past it was more common for companies to use their stock as the matching vehicle in the 401(k) plan and to require that it be held for a period of time. Both are less common today due to a number of lawsuits by employees against companies after significant declines in the price of their employer’s stock. Plan sponsors want to avoid this type of fiduciary liability.

Diversify 

It is important to set a maximum allocation to your employer’s stock in your 401(k) plan and in total.  Use increases in the stock price as opportunities to take profits and diversify. Within your 401(k) plan there will be no taxes to pay on the gains, though there will be taxes due down the road when taking distributions from a traditional 401(k).

Make sure you fully understand any restrictions on selling company shares held in your plan.

Discounted purchases 

Often employees have the opportunity to purchase shares of company stock at a discount from the current market price. This is a great feature but the decision to purchase and how much to hold should not be overly influenced by this feature.

Net Unrealized Appreciation 

If you leave your employer and hold company shares in your 401(k) plan consider using the net unrealized appreciation (NUA) rules for the stock.

NUA allows employees to take their company stock as a distribution to a taxable account while still rolling the other money in the plan to an IRA if they wish. The distribution of the company stock is taxable immediately, at ordinary income tax rates, based upon the employee’s original cost versus the current market value.

The advantage for holders of highly appreciated shares can be sizable. Any gains on the stock will qualify for long-term capital gains treatment where the rates are generally lower. For a large chunk of company stock the savings can be very significant. Note there are very specific rules regarding the use of NUA so it is best to consult with a knowledgeable financial or tax advisor if you are considering going this route.

The Bottom Line 

Holding excessive amounts of your company’s stock in your 401(k) plan can expose you to undo risk should your employer run into financial difficulty. You could find yourself unemployed and with a much lower retirement plan balance if the stock price drops significantly. Set a target percentage for your overall holdings of employer stock and periodically sell shares if needed to rebalance just as you would any other holding in the 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.

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.

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7 Reasons to Avoid 401(k) Loans

December 11, 2014 by 4 Comments
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One of the features of many 401(k) plans is the ability for participants to take a loan against their balance.  There are rules governing what the loans can be used for, the number of loans that can be outstanding at one time, and the percentage of your account balance that can be borrowed.  Additionally there is a time limit by which these loans need to be repaid.

It is the decision of the organization sponsoring the plan whether or not to allow loans and also as to what they can be used for.  Typical reasons allowed are for college expenses for your children, medical expenses, the purchase of a home, or to prevent eviction from your home.

The flexibility offered by allowing loans is often touted as one of the good features of the 401(k).  However taking a loan from your 401(k) also carries some downsides.  Here are 7 reasons to avoid 401(k) loans.  

Here are 7 reasons to avoid 401(k) loans.

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Leaving your job triggers repayment 

If you leave your job with an outstanding loan against your 401(k) account the balance can become due and payable immediately.  This applies whether you leave your job voluntarily or involuntarily via some sort of termination.  While your regularly scheduled repayments are deducted from your paycheck, you will need to come up with the funds to repay the loan upon leaving your job or it will become a taxable distribution.  Additionally if you are under 59 ½ a 10% penalty might also apply.

Opportunity costs in a rising market

While loan repayments do carry an interest component which you essentially pay to yourself, the interest rate might be much lower than what you might have earned on your investments in the plan during a rising stock market.  Obviously this will depend upon the market conditions and how you would have invested the money.  This can lead to a lower balance at retirement resulting in a lower standard of living or possibly necessitating that you work longer than you had planned.

There are fees involved 

There are often fees for loan origination, administration, and maintenance which you will be responsible for paying.

Interest is not tax deductible 

Even if the purpose of the loan is to purchase your principal residence interest on 401(k) loans is not tax-deductible.

No flexibility in the repayment terms 

The loan payments are taken from your paycheck which all things being equal will reduce the amount of money you bring home each pay period.  If you run into financial difficulty you cannot change the terms of the loan repayment.

You might be tempted to reduce your 401(k) deferrals 

The fact that you now have to repay the loan from your paycheck might cause you to reduce the amount you are saving for retirement via your salary deferral to the plan.

You will have less at retirement 

A loan against your 401(k) plan will result in lower nest egg at retirement.  Given the difficulty many in the United States already have in accumulating a sufficient amount for retirement this only adds to the problem.

You should especially avoid 401(k) loans if:

  • You are near retirement
  • You feel that your job security is in jeopardy
  • You are planning to leave your job in the near future
  • You are already behind in saving for retirement
  • You have other sources to obtain the money you need
  • You feel that repaying the loan will be financial hardship 

Look life happens and sometimes taking a loan from your 401(k) plan can’t be avoided.  The economy has been tough for many over the past few years.  However if at all possible avoid taking a 401(k) loan and rather let that money grow for your retirement.  Down the road you will be glad you did.

Please contact me with any thoughts or suggestions about anything you’ve read here at The Chicago Financial Planner. Also check out our Resources page for more tools and services that you might find useful.

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6 Signs of a Good 401(k) Plan

August 7, 2014 by 8 Comments
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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.

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 it’s right for you. Financial coaching focuses on providing education and mentoring on the financial transition to retirement.

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.

Looking to learn more about investing and financial planning? Whether you do it yourself or work with a financial advisor, the Fire Your Financial Advisor online course from the White Coat Investor can help. Make this the year you invest in yourself. Be sure you have the knowledge and the tools to thrive in today’s complex financial environment. (Note this is a affiliate link, I receive a fee if you enroll at no extra cost to you)

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401(k) Loans by the Numbers

June 26, 2014 by 2 Comments
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The topic of borrowing from one’s 401(k) account is always a bit controversial.  Regardless of your view, the folks at TIAA-CREF have compiled some interesting data on 401(k) loans.

Key findings about 401(k) loans 

In their study of 401(k) loans TIAA-CREF found:

  • Getting Out of Debt – Paying off debt was cited as the top reason for taking out a loan from retirement plan savings (46 percent), yet only 26 percent of respondents said it was a good reason to take out a loan.
  • Paying for the Unexpected – The No. 2 reason overall for taking a loan was to pay for an emergency expenditure (35 percent).
  • Borrowing Against Their Savings – Nearly half (47 percent) of those who have taken out a loan from their retirement plan savings borrowed more than 20 percent of their savings, with 9 percent of respondents borrowing more than 50 percent. 

Moreover, they found that nearly One-Third of Americans Have Taken Out A Loan From Their Retirement Plan Savings and that 43 percent of those who have taken loans have taken two or more. 

401(k) loans – some statistics 

The TIAA-CREF study offered some interesting numbers regarding 401(k) loans:

201921_440001_June_Survey_Info_Graphic_v7

 “Women were more likely than men (52 percent vs. 41 percent) to take out a loan to pay off debt; however, men were more likely (40 percent vs. 29 percent) to take out a loan to pay for an emergency expenditure. 

Nearly half (47 percent) of those who have taken out a loan from their retirement plan savings borrowed more than 20 percent of their savings, with 9 percent of respondents borrowing more than 50 percent. 

In addition to borrowing funds from retirement savings plans, many Americans are also contributing less to their plans while they are paying back the loan. More than half of respondents (57 percent) who took out loans decreased their contribution rate during the payback period. Those age 18-34 were the most likely to decrease their contribution amount (81 percent). Forty-eight percent of women kept the same contribution rate while paying back the loan, compared to only 39 percent of men.”

Questions to ask before taking a 401(k) loan 

Morningstar’s director of personal finance Christine Benz recently wrote an excellent piece 4 Key Questions to Ask When Considering a 401(k) Loan.  Christine suggested answering these four questions before deciding to take a loan from your 401(k) account:

  • Does my intended use of funds promise a higher rate of return than leaving the money be?
  • Is my job secure?
  • Can I realistically pay this back?
  • Is my retirement plan on track? 

Is a 401(k) loan right for you?

I’m generally not a fan of using your 401(k) as a piggy bank but the reality is that there can be situations where the money is needed.  Things like a medical situation, a job loss, or other dire situations might necessitate a 401(k) loan. 

In the words of TIAA-CREF Executive Vice President Teresa Hassara: 

“Too many people have struggled since the 2008 financial crisis and have looked at loans from their retirement plans as a way to ease financial stress. However, individuals should weigh all of their options carefully before borrowing from their plan savings or reducing their contributions. Loans can undermine retirement savings and cause investors to miss out on earnings from rising markets. It’s important to evaluate the benefits of taking a loan now against the need for those earnings to build long-term retirement security. Working with a financial advisor can help people make the best decision for their life stage and retirement goals.”

I couldn’t agree more.  Make sure you consider all factors in your financial situation before going the 401(k) loan route.

Approaching retirement and want another opinion on where you stand? Not sure if you are invested properly for your situation? Check out my Financial Review/Second Opinion for Individuals service.

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. Please check out the Hire Me tab to learn more about my freelance financial writing and financial consulting services.  

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Six 401(k) Investing Mistakes to Avoid

May 27, 2014 by 1 Comment
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For many of us trying to save for retirement, our 401(k) plan is our main retirement savings vehicle.  Much has been written about the pros and cons of 401(k) plans, but the truth is that if utilized correctly the 401(k) is a powerful retirement savings tool.  Here are six 401(k) investing mistakes to avoid.

Not contributing enough 

Many plans will set a default salary deferral level for plan participants who don’t specify a salary deferral amount.  Often this is in the 1%-3% range.  While this is better than not contributing at all it is clearly not enough for most of us to build the retirement nest egg we will need.

A standard piece of advice is to be sure to defer a sufficient percentage of your salary to receive the maximum match from your employer.  While I concur with this advice, this doesn’t mean this amount is sufficient to accumulate the retirement nest egg you will need either.

Ignoring outside investments 

If you are early in your career your 401(k) might be your only investment account.  However if you are in mid-career or older you may have a number of accounts including your spouse’s retirement account, several old 401(k) accounts and IRA, or other investments in taxable accounts.  It is important that you view your current 401(k) as a part of your overall investment portfolio and not invest your 401(k) in a vacuum. 

Not investing appropriately for your situation 

This can take many forms.  I’ve seen numerous instances of younger investors in their 20s putting all of their contributions into their plan’s money market or stable value options.  Clearly these participants are not taking advantage of their long time frame until retirement.  It is doubtful that the returns on these investments will allow them to accumulate enough for retirement.

On the other side of the coin there were many stories of plan participants in their 50s who were too heavily invested in equities and who suffered devastating losses in 2008-2009.

The bottom line is that 401(k) investors should invest in a fashion consistent with their financial stage in life, in line with their goals and risk tolerance, in short in a fashion that is consistent with their overall financial plan. 

Over investing in company stock 

No matter how wonderful your company’s stock is investing an excessive percentage of your 401(k) dollars in company stock is risky.  Your livelihood is derived from your job so if the company has problems conceivably you could find yourself unemployed and holding a major portion of your 401(k) in the devalued stock of your now former employer.

As with any investment, having an inordinate percentage of your portfolio in any one holding is risky.  While there is no hard and fast rule, many financial advisors suggest keeping company stock to 10% or less of your overall portfolio. 

Using Target Date Funds incorrectly 

Target Date Funds are the default investing option QDIA) in many 401(k) plans for participants who don’t make an election as to how their salary deferrals are to be invested.  They are also growing in popularity by leaps and bounds as a vehicle for those participants who are uncomfortable allocating their accounts from among the other investment options offered by their plan.

TDFs can be a reasonable alternative if used correctly.  Target Date Funds are designed to be “one stop shops” so to speak.  In other words these funds are designed to be a participant’s only investment in the plan.  The idea here is that the fund will allocate your money in accordance with their glide path to and through the target date.

401(k) investors who use a Target Date Fund in conjunction with several of the other investment options in the plan run the risk of being too heavily invested in one sector or another.  If this is the path that you are choosing make sure you understand the overall allocation of your account that will result and that this is in accordance with your best interests.

Additionally investors considering Target Date Funds need to understand how the funds in the family invest and to understand that the fund with the target date nearest their anticipated retirement age may or may not be the best choice for them. 

Ignoring your 401(k) account when leaving your job 

By the time you are in your 40s you will likely have worked for several employers.  It is critical that when you leave a job that you don’t ignore your 401(k) balance.  It may make sense to leave your money in your old employer’s plan if the plan offers a menu of low cost, solid investment options.  Likewise it might make sense to roll your balance to your new employer’s plan if allowed assuming they offer a solid, low cost investment menu.  The other option to consider is rolling your account to an IRA.  This route will often allow a greater number of investment alternatives and can be a good way to consolidate this money with an existing IRA or to consolidate all of those retirement accounts you might have.

If you are retiring dealing with your old 401(k) is critical as well.  You will want to position your money in line with your needs including continued growth and any withdrawals you will be making from these funds.  If you have company stock as part of your plan don’t neglect to consider the NUA option as well.

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 it’s right for you. Financial coaching focuses on providing education and mentoring on the financial transition to retirement.

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.

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Your 401(k) is not Free

March 16, 2014 by 2 Comments
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Several studies in recent years have highlighted the fact that a significant percentage of 401(k) plan participants don’t realize that their company retirement plan is not free.   Further they were not aware that they often pay all or a portion of these expenses out of their plan accounts.

401K - Perfect Solution !?

A 2011 study by AARP showed that 71% of the 401(k) participants that were surveyed were unaware there were expenses associated with their retirement plan.  The survey also showed a high level of misunderstanding of plan fees even by those who were aware of them.  More recent studies have also shown significant levels of both participants who are unaware of the fees and a high level of misunderstanding, even with the advent of required 401(k) fee disclosures in 2012.

Typical 401(k) plan fees and expenses

There has been an emphasis on the negative impact that high cost 401(k) plans have on the ability of participants to save for retirement via media.  The 2013 PBS Frontline program The Retirement Gamble, for example did a nice job of highlighting the negative impact of high fees on retirement savers.  Some of the expenses that are typical of a 401(k) plan include:

  • Investment expenses.  Here I am primarily referring to the expense ratios of the mutual funds, collective trusts, annuity sub-accounts, or ETFs offered as investment choices by the plan.  Using mutual funds as an example, all mutual funds have an expense ratio whether you invest within a 401(k) plan or outside the plan.  The key is whether the expense ratios of the choices offered by your plan are reasonable.
  • Administration and record keeping.  This includes keeping track of plan assets, participant assets, ensuring that salary deferrals and matching contributions are invested in line with the participant’s elections, generating quarterly statements, as well as various testing and external reporting functions.
  • Custody of plan assets.  This is where the money invested and the mutual funds (or other investment vehicles) are housed.  Examples of custodians might be Fidelity, Vanguard, Schwab, Wells Fargo, etc.
  • Investment advisor.  The fees here are for an outside investment advisor who provides advice to the plan sponsor in areas like investment selection and monitoring and the development of an Investment Policy Statement for the plan.  However, sometimes these charges are simply the compensation for a registered rep who sells the plan to company and may offer little or no actual investment advice. 

Other than mutual fund expense ratios (investor returns are always net of expenses) these expenses may be paid from plan assets (your money), by the company or organization sponsoring the plan, or a combination of both.  For example the plan sponsors who engage my services as advisor to their plan pay my fees from company assets so the plan participants bear none of the cost.

Additionally the delivery of these various functions can be fully bundled, partially bundled, or totally unbundled.  Generally (and hopefully) the outside investment advisor is independent of the other service providers.

Providers like Fidelity, Vanguard, or Principal are example of bundled providers.  They provide the investment platform, custody the assets, and do all of the administration and record keeping.  In an unbundled arrangement, the custodian, record keeper, and the investment advisory functions are all separate and provided by separate entities.

Neither arrangement is inherently good or bad, it is incumbent upon the organization sponsoring the plan to monitor the costs and quality of the services as part of their Fiduciary duty to you the plan participant.  Plan sponsors should insist on transparency regarding all provider expenses.

BrightScope 

BrightScope is a service that independently rates 401(k) plans on a number of criteria.  Check to see if your company’s plan is ranked by them at their site. 

Mutual Fund expenses 

The required fee disclosures that I mentioned above focus on the plan’s investment options and their expenses.  You should start seeing them in the near future.

While they may not look particularly informative and don’t delve into the plan’s total costs, the investment expenses can be telling none the less.

If your plan is via a large employer, you may see institutional share class mutual funds with very low expense ratios.  As an example my wife works for a division of a Fortune 150 company and some of the index funds available to her have expense ratios less than 0.05% which is very low.

In fact looking at the fund share classes offered by your plan is also revealing.

The American Funds offer six share classes for retirement plans ranging from R1 to R6.  Using the popular American Funds EuroPacific Growth fund as an example you can see the differences in the expenses and the impact on return below.

Ticker Expense Ratio 12b-1 5 Year return
R1 RERAX 1.61% 1.00% 15.35%
R2 RERBX 1.60% 0.74% 15.35%
R3 RERCX 1.14% 0.50% 15.90%
R4 REREX 0.85% 0.25% 16.24%
R5 RERFX 0.55% 0.00% 16.58%
R6 RERGX 0.50% 0.00% 16.62%

Source:  Morningstar as of 3/14/14

Looking at this another way, $10,000 invested in the R1 and R6 share classes would have grown to the following amounts by February 28, 2014:

R1  $20,915

R6  $23,022

I think you will agree that this is a rather significant difference.

The 12b-1 fees are included in the fund’s expense ratio and generally go to compensate the plan provider, the registered rep or broker who sold the plan or other service providers.  In the case of the American Funds you generally see the R1, R2, and R3 shares in higher cost, broker sold plans.

Similar share class comparisons can be made with other mutual funds in many other families including Fidelity, T. Rowe Price, and even low-cost Vanguard.

According to Morningstar data as of 12/31/13 here are the median expense ratios for the following investment styles:

Large Blend 1.07%
Large Growth 1.15%
Large Value 1.07%
Mid Cap Blend 1.16%
Mid Cap Growth 1.24%
Mid Cap Value 1.24%
Small Cap Blend 1.23%
Small Cap Growth 1.36%
Small Cap Value 1.31%
Foreign Large Blend 1.23%
Intermediate Bond 0.79%

 

While these are median expense levels I would say that for the most part if the funds in your plan are at these levels they are too expensive.  Index funds across these categories should be 0.25% or less.

Several studies have concluded that the biggest determinant in retirement success is the amount saved.  None the less having access to a solid, low cost 401(k) plan as vehicle for retirement investing is a big plus.

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. Please check out our resources page as well.  

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What if My Company’s 401(k) Plan is Lousy?

December 17, 2013 by 7 Comments
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Financial advisors (including yours truly) generally suggest maximizing contributions to your company’s 401(k) plan.  But what if your 401(k) plan is lousy?  Here are some tips to help make the best of a lousy 401(k) plan.

401K

Lousy defined 

In what has become the most read post on this blog, 4 Signs of a Lousy 401(k) Plan, I discussed these four characteristics of lousy plans:

  • An investment menu consisting of proprietary mutual funds
  • Single fund family investment menus
  • Expensive share classes
  • A group annuity  “wrapper” around the plan 

So what can you do to make the best of a lousy 401(k) plan?

Invest in the best funds in the plan

Even if your plan is lousy often there are at least a couple of decent mutual funds in the plan.   Consider focusing your contribution in these few investment choices and using investment dollars outside of the plan to complete your portfolio’s overall asset allocation. 

Get the full company match

If your company matches your contributions, contribute at least enough to receive the full company match. For example, if your plan offers to match half of all contributions up to 6 percent of your salary, that’s an extra 3 percent contribution from the company, which gives you an instant 50 percent “return” on your money. That’s hard to beat. 

Contribute to an Individual Retirement Account (IRA)

Everyone can contribute $5,500 ($6,500 if you’re age 50 or over) to an IRA for 2013 and for 2014.   The deductibility of a traditional IRA contribution will depend upon your income and whether you are covered by an employer’s retirement plan.  Likewise, with a Roth IRA there are income ceilings that determine whether you can make a Roth contribution. 

Take advantage of other retirement savings options

If your spouse’s company offers a better 401(k) plan try to maximize your contributions to that plan.  Do you run a business on the side? If the business is generating income, consider starting a retirement plan. Among the options to consider are a SIMPLE, a SEP-IRA, and a Solo 401(k).  Remember that any contribution limits will apply to your company retirement plan and your self-employed retirement plan combined. 

Discuss your concerns with your employer  

Do your homework and outline your concerns with the plan. With new 401(k) disclosure rules that went into effect in 2012, your plan administrator may be more receptive to your input. Of course, common sense and civility should prevail when bringing concerns to the company’s attention.

401(k) and similar defined contribution retirement plans represent an excellent retirement savings vehicle.  The ability to contribute via ongoing salary deferral is a painless way to invest for retirement.  Sadly some employer retirement plans are quite lousy.  If yours is one of these plans make sure to look for additional ways to save and invest for your retirement and be diligent in making those contributions.

Please contact me at 847-506-9827 for a complimentary 30-minute consultation to discuss your 401(k) plan and all of your investing and financial planning questions. Check out our Financial Planning and Investment Advice for Individuals page to learn more about our services.  

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Five 401(k) Investing Tips for This or Any Market

November 8, 2013 by 6 Comments
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Benjamin GrahamThe Dow Jones Industrial Average has hit something like 30 new highs this year alone, the S&P 500 is near record levels as well.  Twitter just went public and Obama Care will go into full swing in 2014.  What does any of this mean to you as a 401(k) investor?  Here are five 401(k) investing tips for this or any market environment.

Rebalance your account 

If you’ve let your holdings run it’s quite likely that your account is over allocated to equities given the strong showing the stock market has made so far in 2013.  This would be a good time to look to rebalance your account back to the original allocations that you had intended.  Paring back on stock funds might seem counterintuitive, but essentially you are taking some of your gains off of the table in order to keep the risk associated with your overall portfolio in line.

Consolidate and coordinate 

If you are just starting out in the workforce, it’s likely that your 401(k) is your lone investment vehicle.  By the time you get to your 30s or 40s and beyond it’s likely that you’ve switched jobs several times and have left a number of old 401(k) accounts or IRAs in your wake.  If you are married and both working multiply this financial clutter by two.

Consider consolidating your old 401(k) accounts either in a rollover IRA or into your current employer’s 401(k).  Looking after a number of scattered accounts is counterproductive and makes viewing all of your investment holdings as a consolidated portfolio that much harder.

While we are on the subject, ALWAYS view your 401(k) account as a part of an overall consolidated portfolio.  I create a spreadsheet for each client to do just that, with all of the technology available today this is not difficult, but it may take just a bit of time to lay things out the first time you do it.

The reason for this approach is so that you view your overall asset allocation and the diversification of your portfolio across all investment and retirement accounts.  Are you taking too much risk or not enough?  Do you own the same fund in three accounts all in different share classes?

Increase your salary deferral

This is the time of year where many companies have their employees go through Open Enrollment for their employee benefits.  While you are thinking in terms of benefits this is a good time to boost your salary deferral to ensure that you are contributing the maximum to the plan.  If you can afford it and are not on track to max out for 2013 ($17,500 and $23,500 if you are 50 or over) arrange to have more withheld for the rest of this year and figure out what percentage to apply to your first check in 2014.  How you invest your 401(k) is important, but studies have shown that the amount you save for retirement is the biggest single factor in determining the size of your nest egg.

Don’t default to the Target Date Fund

One of the Target Date Funds offered by your plan might be the right choice for you.  This may be the fund with the target date closest to your anticipated retirement date or some other fund in the series.  It is important that you understand what is under the hood of the Target Date Funds and decide if this is the right approach for you.  Note these funds change from time-to-time as witnessed by some recently announced changes that Fidelity will be making in its Freedom Funds. 

Get the help you need 

Many plan sponsors are offering advice options ranging from online advice to one-on-one advice to managed accounts.  Check out these options and any fees associated with them.  If you work with a financial advisor make sure that they are providing you advice on how to allocate your 401(k) account along with the advice they provide on your other holdings.  Some 401(k) participants are savvy investors, others are not.  If you are in this latter camp, bite the bullet and hire the advice that you need.  This is important, it’s your retirement, and you only have one shot at it.

For better or worse the 401(k) and similar retirement plans are the main source of retirement savings for most of us.  Make the most of your plan regardless of what is going on in the markets or the economy.

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.

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Led Zeppelin and Your 401(k)

August 16, 2013 by 6 Comments
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Andrea Coombes recently wrote an excellent piece for Market Watch entitled “401(k) savers are confused and stressed.”   The title of Andrea’s article reminded me of the classic Led Zeppelin song Dazed and Confused.  Led Zeppelin is perhaps the greatest rock band of all-time.  Lead singer Robert Plant and guitarist Jimmy Page are true rock legends.  Dating myself a bit, I still have the original vinyl versions of Led Zeppelin II and Led Zeppelin III that I bought in my early teens.

Led Zeppelin -- Led Zeppelin

Whether you prefer Andrea’s article title or the title of the Led Zeppelin song, the confusion felt by many 401(k) investors is real and is an impediment to retirement success.

Schwab Survey 

The Market Watch article cited several findings from a Charles Schwab survey of 1,004 people who invest in a 401(k):

“But more than half of the 401(k) savers said their plan’s investment options are more confusing than their health-care benefits, and 57% said they wish it were easier to choose among their plan’s investing choices.

Forty-six percent of savers said they don’t know what their best investment options are, and 34% said deciding how to invest in their 401(k) is causing them a lot of stress. (The survey respondents ranged in age from 25 to 75, and worked at companies with 25 or more employees.)”

Too many choices 

A 401(k) plan sponsor for whom I serve as advisor had a menu of over 150 distinct choices when we first started working them.   We have worked with the sponsor and the plan provider to pare down  the menu to three tiers that include access to Target Date Funds; a menu of 16 core individual mutual funds; and access to a brokerage link for those participants who prefer a purely self-directed approach.

A 401(k) with too many choices always reminds me of my frustration with many of the excellent family restaurants here in the Chicago area.  The menus are complete to the point of being like a small encyclopedia and all the choices look great.  Add to that a desert display when you walk in and making a final selection is often difficult.

Target Date Funds 

I’ve long had a love-hate relationship with Target Date Funds.  On the one hand I love the idea of a professionally managed, instantly diversified portfolio.  For young 401(k) savers like my 25 year daughter I think this is a great option.  She gets instant diversification and a portfolio that is appropriately aggressive for her age.

For investors in their 30s and 40s and beyond I’m not as sold on Target Date Funds.   By this time I’d hope that you’ve accumulated some investment assets and are ready to take charge of your financial future.  To me this means that you have a financial plan in place that includes an investment strategy tailored to match your individual financial goals.

If you decide to go the Target Date Fund route make sure that you understand the underlying investments of the funds as well as the fund’s expense ratio.  Remember that you are not obligated to invest in the fund with the target date closest to your anticipated retirement date.  Lastly remember that Target Date Funds from different families with the same target date may be vastly different.  Do your homework before investing.

401(k) investing tips

In an earlier post on this blog, I listed 5 timeless tips for 401(k) investors:

  • Stick with it
  • Contribute as much as you can
  • View you 401(k) as part of your overall portfolio
  • Don’t ignore your 401(k)
  • Use Target Date Funds with caution

To these tips I’d add two others, keep it simple and get outside help if you need it.

Many plans offer low cost index fund choices.  For example a relatively simple, but diversified portfolio could be constructed from say a Total U.S Stock Index fund, a Total International Stock Index fund, and a Total Bond Market Index fund.

If you need outside help to allocate your 401(k) as well as your other investments, get it.  Many 401(k) plans offer advice or managed accounts that are more tailored to the individual participant’s situation than a Target Date Fund.  Beyond this consider hiring a qualified Fee-Only financial advisor to help you.

A 401(k) plan can be a daunting and intimidating investment vehicle.  Being dazed and confused is great when listening to Led Zeppelin.  However this state of mind has no place in plotting your financial future.

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 it’s right for you. Financial coaching focuses on providing education and mentoring on the financial transition to retirement.

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.

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