Why the 401 K Plan Might Not Be the Best Option
Employees are fighting back against their company’s 401 K plan and suing their employers based on excessive fees and costs. Some of these lawsuits are legitimate. Some employers are not acting in their employee’s best interest. At the same time, many of these lawsuits don’t make sense. Yes, cost is a consideration. However, it is not the sole reason that 401 K plans are not always the best option.
There really is only one reason you would want to invest into a 401 K plan. It is the free money that comes along with the employer match. If an employer is willing to give you money for participating, then you would be crazy not to participate. Beyond contributing up to the match, you need to do some investigation to make sure it is worth using the 401 K plan as your primary investment vehicle.
Here is what you need to check:
I doubt that this will be a problem given a year or so of lawsuits. I am sure that employers are double checking to make sure that their retirement plans are priced efficiently
Check and make sure that the plan is charging reasonable fees. What are reasonable fees? The same fees that you would be paying for mutual funds outside of the plan. Most of the time you will find the same funds in your plan offered to the retail investor through a broker. For instance, Fidelity Growth Fund can be the same fund within the 401 K plan and available outside of the plan through Fidelity. They should have the same expense ratios. You can go to www.morningstar.com and see what each fund should be charging. I definitely wouldn’t be helping fund a commission to an advisor or paying for administration costs. Further, I wouldn’t be paying an advisor a management fee for doing nothing.
This is where most 401 K plans let people down. There are two ways to look at choice. First, there is number of available funds. If your 401 K plan only has 6 to 8 funds, then that is a problem. It is tough to properly diversify a portfolio with a limited number of funds.
Then there is the type of funds for the purposes of diversification. If you have a plan that has 20 funds in it and 18 of the twenty funds all do the same thing, then that is not a very good plan. Most 401 K plans are only set up for moderate or higher risk investors. Today most 401 K plans don’t have conservatively based stock funds that are needed for conservatively based investors.
Unfortunately, 401 K plan providers are moving towards using just index funds that track investment indexes such as the stock market. Most of those index funds would not be appropriate for a very conservative investor because they are taking 100% market risk.
If not a 401 K plan, then what do you use?
First, you can see if an IRA makes sense. Beyond that you can also set up a taxable investment account. There are plenty of options.
The bottom line is that you want to be saving, investing, and managing for risk. The type of account you use is secondary.
Bob Brooks is host of the Prudent Money Radio show. Bob is also a financial advisor who helps people set and achieve financial goals. For more information or to set up a phone consultation, email Judy Parrish at firstname.lastname@example.org .