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Wednesday, May 18, 2016

401k Fees are Falling...Are Yours ? Some Tips on Your 401k in a Lower Cost Environment

The WSJ reports some good news for 401k investors:

401(k) Fees, Already Low, Are Heading Lower

Employers, advisers shave retirement-plan costs as they face pressure to monitor expenses

On average, the fees 401(k) participants pay for funds that invest in stocks fell from 0.77% of assets in 2000 to 0.74% in 2009, before dropping sharply to 0.54% in 2014, according to ICI, a mutual-fund-industry trade group. Fee reductions have also accelerated on bond funds and a hybrid category that includes popular all-in-one target-date funds.

Companies are lowering fees through various channels. More than 60% of 144 large employers said they were very or somewhat likely to move money this year into less-expensive share classes of the mutual funds on their plan menus, according to a survey Callan published in January. One-third of the respondents said they planned to renegotiate administrative fees. And 14% said they would switch some or all of their investment options from actively managed funds to index funds, which generally cost less.

These are positive developments of course and if your 401k plan still has high fees you should consider contacting those responsible within your corporation. Int the current environment of more regulatory scrutiny --and large class action suits against corporations with high fee 401ks-- your complaints may well elicit changes.

 You should make every effort to understand all the fees in your 401k plan both administrative charges and the management fees of the funds available.

But even if the fees have come down and there are index fund options there are still other issues to consider to make the best use of your 401k particularly when you have assets in other accounts such as IRAs and taxable accounts.

  • Just because it is an index fund doesn't mean it is low cost: The growth of index funds and ETFs has meant a race tot he bottom in management fees..with funds and ETFs in many stock and bond categories reaching below .10%. For example the Vanguard Total Stock Market Index Fund carries a management fee of just .05%.
          But it is not at all uncommon to find 401k plans with index funds carrying management fees
         that are far higher. There is no justification for a plan to include a total stock market index or S+P 500 index fund with a fee of .50% but that is not uncommon.  Including ad S+P 500 index fund and justifying a .50% fee because it is significantly less than the actively managed funds in the plan is likely to raise issues in terms of the fiduciary standard .

  • In what asset classes are index funds available ? It is quite common for a broad capitalization weighted US stock market index fund based on the total stock market index or an S+P 500 index fund  to be available.
  • But a diversified portfolio should include small cap stocks. Yet small cap stocks have a very low weighting in total stock market index and no representation in a S+P 500 index.
  • A diversified portfolio should also include international stocks so a 401k plan should offer choices in international equities as well.
  • And a broad range of choices among bond index funds should allow a mix of short and long term bonds, government and corporate rather than just a single bond index fund.
Beware the target date funds: Many 401k plans now offer target date funds and some may even have the target date fund as the default option. But target funds may not be a good choice. The funds set a balance between stocks and bonds based on age/expected date of retirement and then adjusts the mix of stocks and bonds reducing the stock allocation and moving assets to bonds as retirement approaches--the glide path"

It is important that the investor understand the glide path and whether it fits with their plans. A spouse's age or retirement plans and what other assets are available for retirement are just two examples of factors that may mean the "glide path' of the target date fund is appropriate.

What is in the target date fund ?. There is an asset allocation within the target date fund it is important to know what is used for the stock and bond allocation: are they index funds or actively managed funds? international and domestic stock funds? what are the bond allocations.

All of the above would argue that many investors would be better off constructing their own allocation for their 401k rather than setting it on auto pilot with a target date fund/

Putting your portfolio together: Your 401k + your other investment accounts

The emergence of lower fees in 401k plans is definitely a positive environment.

Creating a comprehensive asset allocation involving your 401k and that of your spouse as well as other assets such as IRAs and taxable accounts is the best approach to meeting your investment goals.

Here are some tips:

Bonds go into tax deferred accounts: Because income in IRAs and 401ks are not taxed currently and interest income is taxed at ordinary income rates it makes sense for most investors to put their bond allocation in tax deferred accounts.

Optimize  the use of index funds in your 401k . No 401k plan will include as wide a variety of index funds as are available in the index fund and ETF marketplace which you can access with your taxable or IRA accounts.

That means that you should use the index funds available in your 401k to implement parts of your asset allocation and your outside account when necessary to fully implement the asset allocation.

Create an Overall Asset Allocation not just an Allocation for the 401k

For example your overall allocation might call for a traditional capitalization weighted index as well as allocations to value or small capitalization stocks , developed international and emerging markets. But your 401k plan might not offer index funds in all those categories.

To implement  the allocation  401k funds would be used to fill the capitalization weighted US stock index part of the allocation and the accounts outside of the 401k would be used to purchase ETFs in the other categories of the asset allocation.

It is also not uncommon for a couple to find that the 401k plans of each employer have different choices. One plan may include a small capitalization index fund which could be used to fill that part of the allocation while the other plan may only include an S+P 500 fund,

Rebalance:  Investors tend to chase performance buying high and selling low..the opposite of what is done when one rebalances back to a target allocation. Many 401k plans offer autormatic rebalancing. But that rebalancing isnt done at the portfolio level taking into considerations all the investment accounts.

Consider Getting  Assistance form An Outside Professional

The lower fee environment for 401ks and the changes in regulations on advice for rollovers from 401k plans to IRAs are a very positive development. But as can be seen above implementing the proper asset allocation strategy is still far from simple. There are various ways a professional advisor can help

Periodic consulting: If the vast majority of your assets are in your 401k all you may need is a consultation with a professional to personally review your situation and recommend an asset allocation . An annual review would likely be optimal as well. Investment professionals should be able to offer that service as well.

Comprehensive asset management: Some 401k plans allow investors to have an advisor manage their 401k plan. For investors that have a portfolio consisting of significant assets outside of the 401k plan it might be optimal for the investor to have an advisor manage all the assets therefore taking care of the asset allocation and rebalancing .

Asset Management + Consulting: In the cases where the investor cannot or does not want to have an advisor directly manage their 401k assets a hybrid approach may be best. The advisor would have direct management of the non 401k assets and then work with the investor on a consulting basis with regard to the 401k assets making sure there is an integrated asset allocation and rebalancing.

I work with clients in all these services with clients in person in the Southern California area and by skype/email throughout the US.

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