For years, even before I got into the industry, I've heard participants complain about companies' their 401(k) plans. This longing for a better 401k plan grew from complaints that ranged from lack of fund choices and lack of employer matching contributions to high expenses in their fund choices. ERISA requires 401(k) plans to provide at least three different investment options so that employees can diversify investments. A good retirement plan will have more than three options which include at least one choice for bonds (better plans will have one short term and one total bond fund), domestic stocks (better plans break these down by small-cap, mid-cap and large cap funds) and international stocks. Anything less is worth complaining about.
Asking an employer to match employee contributions can become a large expense for a company and should be considered a bonus for a plan and not a benchmark of what makes a good plan. Some companies pay lower salaries which affords them the ability to match contributions. Be careful what you wish for. It's not always an even comparison. Personally, I've never worked for a company that matches my contributions and my retirement account balance is on track for my age and retirement goals, but then again I started contributing with my first job out of college when I was 22. Participating is the most important step an employee can make. Participants shouldn't blame their 401(k) plans for their own lack of contributions.
High 401(k) plan expenses is the one area I almost always agree with participants is an area worth complaining about, especially since it's not hard to fix. Plan sponsors are fiduciaries and part of their obligation to the plan and its participants is to keep expenses reasonable. The problem is that many sponsors (and participants) do not realize they are being charged as much as they are. Mutual fund companies have gotten really good at hiding fees. The most common hiding place is in expense ratios. Most actively managed funds charge 12b-1 fees which can be as high as 1% of assets. These fees go to pay for advertising and marketing for the fund. Investors do not benefit from this, mutual fund companies do. Also hidden within the expense ratios are the fees that the active fund managers receive. Together these fees can reach as much as 2% in some cases. If your 401(k) plan is paying for an advisor to help you do not need to pay a fund manager extra to manage a fund that is not catered to you. You are better off using the advisor your company has already hired and getting a retirement plan catered to your individual needs.
Some advisors might argue that part of these high fees is used to reduce the plan's administrative expenses through revenue sharing. That makes as much sense as considering a return of a security deposit as income. This is money that participants are paying to themselves essentially and when they get their payback it's lighter than when they made the deposit after the advisors take their cut (aka kickbacks). The average actively managed fund’s expense ratio is 1.25%. 80% of all actively managed mutual funds fail to beat their benchmark index in any given year. Why would you ever pay for an actively managed fund, especially if you are paying your investment advisor too?
What can you do?
- When you leave a company consider taking your retirement assets with you and roll it directly into an IRA.
- Find an advisor who uses ETFs and/or low cost index mutual funds and doesn't make you pay extra for a sub-par investment.
- Talk to your plan sponsor (the one who organizes your 401(k) internally, typically someone in HR or your CFO) and ask why your plan offers so many expensive funds and so few (if any) low cost index fund choices. As with any problem you present at work you should bring a solution too. An easy solution is to refer your sponsor to AF Capital Management where we offer access to mutual funds with expense ratios at or below 0.3% and ETFs with expense ratios at or below 0.2%. All of our fees are completely transparent. We do not accept any revenue sharing arrangements with mutual fund companies.
