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

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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.

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