A Better Plan

Adam M. Grossman

TED BENNA, INVENTOR of the 401(k) retirement plan, famously once stated that the system he created should be “blown up.” Why? It isn’t the fundamental structure, which he still believes in. What he doesn’t like is the complexity and costs that characterize today’s typical 401(k).

The original 401(k)s, he likes to point out, had just two fund options. Today, it’s more like 20. Because of that, it’s all too easy for bad investments and high fees to sneak in. That’s what Benna doesn’t like.

In my work as a financial planner, I often see the innards of different 401(k) plans. While each has its pros and cons, last week I saw a particularly glaring example of what Benna dislikes so much.

In the retirement plan of one of Boston’s preeminent institutions, the only cash investment option is a money market fund that charges 0.37% per year. While that may sound like a tiny number, such seemingly small fees can have a destructive effect on our wealth.

To assess the fee’s fairness, we should ask, “What portion of the fund’s profits did the fund managers take for themselves—and how much did they leave for investors?” After fees, this fund’s return last year was 0.67%. If we add back the fee of 0.37%, we can calculate that the fund gained 1.04% before costs. That was the total amount of profit that was available to split between the fund manager and the fund’s shareholders.

The fund manager took 0.37 of that 1.04. As a percentage of the total profits, that translates to 36%. That’s a galling figure—the kind of thing you’d expect to see in a hedge fund, not in a simple money market fund and certainly not in a retirement account.

It gets worse. When I pointed out this fee imbalance, the employee contacted the firm that runs the fund. The firm’s response: That fee, a representative said, is “relatively normal.” This I found particularly surprising. Instead of acknowledging that the fund isn’t a great deal, the rep tried to explain it away as normal. Or relatively normal. I suppose if you’re riding in a clown car, it’s relatively normal for the guy next to you to be acting like a clown. But that’s certainly not who you want safeguarding your retirement savings.

If your employer won’t protect you from such fee-gouging, how can you protect yourself? Try these five strategies:

1. Look for index funds. Yes, some actively managed mutual funds can outperform, but only a minority do. By favoring index funds, you stack the odds in your favor.

2. Find out what each fund costs. It isn’t enough for a fund to be an index fund; It has to be an appropriately priced index fund. Often, the cost information—called an “expense ratio”—is listed only in supplemental documents, but your HR department can provide them to you.

3. Get the ticker symbol for each fund you’re considering. This is important, because many funds have similar sounding names, but the ticker symbols are unique. This will allow you to research funds using objective, third-party resources like Morningstar, which has a free, online database.

4. Be cautious of target-date funds. While these are great in theory, fund companies also know how much consumers like them. As a result, I often find them loaded with fees. You can often achieve the same objectives as a target-date fund, but at much lower cost, by combining two separate, simpler funds.

5. Don’t settle. In many cases, a 401(k) menu will offer a handful of good, low-cost funds, but not enough to create an ideal portfolio. That’s okay. Just buy what you can within your 401(k) and then compensate with supplemental purchases in another account outside your 401(k).

Adam M. Grossman’s previous articles include Diversify Five Ways, About That 22% and You Lose, They Gain. Adam is the founder of Mayport Wealth Management, a fixed-fee financial planning firm in Boston. He’s an advocate of evidence-based investing and is on a mission to lower the cost of investment advice for consumers. Follow Adam on Twitter @AdamMGrossman.

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