Do You have a Good 401(k)?

In today's world where we are responsible for our own retirement, a good 401(k) is extremely valuable.  If you are young and you have a good 401(k) and you take advantage of it, you are on the track to spending the last third of your life in really, really good shape.

Don't know how to do it?  Read this blog or hundreds like it, or read Millionaire Teacher by Andrew Hallam or The Elements of Investing by Malkiel and Ellis.  These books will take you two weekends, at most, and will put you on the aforementioned path.

But how do you know if you have a good 401(k)?  One thing you might want to do is visit www.brightscope.com where you may find your company 401(k) listed and rated.

Another approach is to read

 7 Clues That Your 401(k) Plan Sucks by Robert Berger.

Incidently, his website Dough Roller is one of my favorites that I check weekly for the articles he lists!

In this article he wrote for Daily Finance, Berger has the following important points to examine on determining the quality of your 401(k):

• employer match - in just about every instance, a match should be taken advantage of.  How do you find if you have a match?  Ask Human Resources or look at a recent statement.  Statements will have "employee contribution" and "employer contribution"(if any) listed.
• Roth 401(k) - if you have a Roth 401(k), it is good; and consideration should be given to using it.  Know that you won't get the upfront tax break for using it; but, going forward, you'll never worry about taxes again (assuming Congress doesn't change the law ;).
• Index Fund offerings - generally, if you don't have low-cost index fund offerings, then you should limit your contributions to the company match and use an IRA elsewhere.  If you aren't sure of what a low-cost index fund is, read the above mentioned books.  If you have low-cost index fund offerings (example: Fidelity Spartan Funds), then your path to a successful retirement is straight forward.  Use them to the fullest extent allowed!

Berger's article lists other important considerations.  One important point to note is at the very beginning where a lawsuit is referenced concerning a Plan Administrator.  If your 401(k) has only high-expense fund offerings, you may want to highlight the case mentioned with a yellow highlighter and drop it off in your Human Resource person's mailbox.  The days of clueless administrators choosing poor fund choices for plan participants is slowly coming to an end.

Need Help Allocating 401(k) Investments?

source: www.capitalpixel.com

One of the good things about the financial services industry is that there are people who constantly seek opportunities to provide what the market needs.

One service desperately needed is objective advice on allocating 401(k) assets.  In fact, this is an important part of what I do.  Very basically, I look at the total asset picture of clients and manage their assets or recommend asset allocations for them.  I use an approach that stresses tracking markets using low-cost well-diversified ETFs and mutual funds.  My reading of the evidence is that this approach will outperform active managers over the long term after all fees are accounted for.

Many prefer an active approach.  From my perspective, that's ok. There is more than one way to skin a cat, and time will tell if an active approach will add value.

With this being said, there is a free, fund-specific service, Kivalia, that helps investors with asset allocation in their 401(k)s (and 403(b)s and 457s, etc.).  If a fund isn't presently in the more than 225 funds listed, it can easily be listed.

Once in the database, the service produces 3 recommended fund-specific asset allocations illustrating 3 risk tolerances as shown:

Source: www.kivalia.com

CLICK IMAGE TO ENLARGE  On the same page, clicking an icon will enable you to compare the asset allocation of your own portfolio.  Are you more aggressive or more conservative than you think?  Also shown is the performance of the portfolios along with relevant target date funds.

For those who like pie charts, the asset allocation is also shown as follows:

www.kivalia.com

CLICK IMAGE TO ENLARGE Once on the page, you'll also see useful risk and diversification metrics.

To get the full utility of kivalia (the website has the genesis of the word, which you'll find interesting), you have to putter around on the site.  You'll find the ability to be notified of alerts when changes are recommended and that there is a lot of guidance and useful information for those puzzling over the asset allocation decision.  I would suggest that plan administrators take the lead and advertise this service to employees.  They should be pro-active in getting their plans listed and promoting objective advice on investments.

The principals of Kivalia have strong credentials to provide the advice offered.  I would, however, like to see an explanation of how various factors are weighted in arriving at the recommendations.  For example, as readers know, I and many others emphasize costs of funds as an important long-term performance factor.

Disclosure:  I am not affiliated with Kivalia.  This post is for educational purposes only.  Individuals should do their own research or consult with an investment professional before making investment decisions.

Oriole Esskay Hotdog Race and Investing

Last night found me at Camden Yards (courtesy of an invite from my buddy Mike) watching the Orioles whup up on the lowly K.C. Royals.  Walk-up tickets sold were the largest in the franchise's history, and the atmosphere felt like an ALCS playoff game. Excitement is building as the Orioles continue to lead the division and major league baseball in wins.

As those who have been out to the Yard know, one of the popular, albeit goofy, side entertainments is the Esskay Hotdog Race where three cartoon hotdogs race on the jumbo screen.  The crowd jumps up and down and yells for their favorite.

Anyways, it struck me that picking a favorite hotdog in the race is probably similar to how many 401 (k) participants pick their investments.

This particular problem was on my mind because, in the morning, I had met with a young lady who works for the county and sought my help "getting started and learning about investing."  She told me she was the first one in her family to invest and is excited to learn the process.

An important part of the process that sometimes confuses people is choosing which funds to invest in.

As I watched the hotdog race, I reflected that probably 20% or more of the baseball crowd had likely faced this issue, via the exact same investment vehicle The Maryland Teachers and State Employees Supplemental Retirement Plans.

So how do you choose which funds to invest in?  Some plans have a ridiculous number of choices, and this is one area where research has shown that too many choices can be detrimental.  Thankfully, the Maryland Plan has a reasonable number of choices.

Some participants throw up their hands and go with target date funds.  These funds set an allocation based on your expected retirement and make rebalancing moves over time.  This is OK and is a lot better than not participating.  But choosing funds directly is a less costly method that can more accurately reflect risk tolerance.

Picking Funds

By the time you've come to pick funds, you've already picked an asset allocation model.  The young lady and I agreed to start with the "Moderate Model" which is basically 60% stocks and 40% bonds. Even though she is young and can stand some volatility, we thought it best to start a bit conservatively.  I explained, since she will be contributing on a regular basis, that the best thing for her would be for the market to drop 50%!  What is important to her is where the market is 30 years from now - not what happens over the next few years.

The "Moderate Model" specifies 30% allocated to "Large-Cap Stock Funds."  The choices offered are shown in the following table along with 1-year, 3-year and 5-year performance numbers:

FUND	Ticker	Exp Ratio	1 Yr.	3 Yr.	5 Yr.
Neuberger Berman Partners Fund Inst.	NBPIX	0.69%	-7.81%	23.60%	-1.43%
Vanguard Instl. Index Fund Plus	VIIIX	0.02%	8.54%	23.47%	2.07%
Parnassus Equity Income Fund Inst.	PRILX	0.75%	5.73%	20.67%	5.97%
S&P 500			8.54%	23.42%	2.01%

There are actually 3 additional choices, but they are not "Large Blend."  "Large Blend" means that the funds blend value stocks (i.e., those with low P/Es) and growth stocks (i.e., those with higher than average earnings growth).

So how do we choose?  Is this like picking in the cartoon hotdog race?  Should we throw darts? Actually there are well-defined principles supported by academic research and recommendations from leading market analysts.  Those who support this approach include Warren Buffett, Burton Malkiel (author:  A Random Walk Down Wall Street), Charles Ellis (author:  Winning the Loser's Game), Andrew Hallam (author:  Millionaire Teacher), and, of course, John Bogle, founder of the Vanguard Funds.

The process is straightforward:  pick funds that have low expense ratios and closely track the overall market.  This leads us to choose the Vanguard Fund with its .02% expense ratio and close tracking of the S&P 500 stock index.

As you go through this exercise, you notice that the low-cost index fund is not the best performer over some periods.  That's fine and to be expected.  It may not even be the best performer in the future.  What you get when you pick a low expense ratio fund that tracks the market is a fund that will beat 8 out of 10 competitors in a long-term race.

One point that gets a bit tricky is style.  Are the funds really "Large Cap Blend?"  To check this, go to Morningstar and put in the ticker symbol.  Do this for PRILX, the Parnassus fund listed above, and scroll down a bit.  You come to what is called the "Style Box":

Source: Morningstar

We find that, rather than a Blend, it appears the manager has tilted towards Growth.  A sausage has snuck into the race!

Scrolling down on the same page will show you as well that the fund has a brand new manager!

Disclosure:  The information here is intended for education purposes.  Individuals should do their own research or consult with a professional before making investment decisions.

Largest Employer of Certified Financial Planners Sued

In late September, six people, including a current employee, sued Ameriprise Financial on issues related to its 401(k) plan, as described by Lieber in "Financial Planner's Red Flags."  There are several ongoing suits against 401(k) plans on the basis of cost and performance results.  This, to my knowledge, is the first suit brought against a financial services firm by its employees - those who sold its products!

Sadly, this occurs despite the voluminous evidence that actively-managed funds underperform over the longer term after fees. By choosing actively-managed, highly touted funds that have had superior performance in the past, participants are playing what Charles Ellis refers to, in the Wall Street Classic,  as "The Loser's Game."

In the Ameriprise suit, the plaintiffs argue that the plan is "stuffed" with high-cost, poor-performing funds managed by the company.  Lieber's piece details some of Ameriprises' history that gets me to wonder why, frankly, people do business with them.  But, then again, this is true of many of our largest financial services organizations.  They participate in every sleazy financial event that comes along from doing illegal barge, earnings manipulating, buybacks with the likes of Enron to pushing inappropriate derivatives on unsophisticated municipalities.  And yet people trust them with their money!

I understand that there are always a few bad apples in a large organization, especially when compensation is determined by product sold and there are huge incentives to put clients in inappropriate investments.  This is not what this is about.  It is about the culture of these companies.  They exploit the lack of knowledge of consumers and, in the end, create problems for the country by putting people's retirement at risk.

The article points out:

It has to be frustrating for Ameriprise to see its menu of mutual funds splayed out for all of the world to see, complete with details on poor performance and a handy chart showing fees that are three to five times what they are at Vanguard.

I, for one, have no sympathy.  Thankfully, fee disclosure is on the way next year for all 401(k) providers.

Along with many others, I recommend individuals do considerable research and at least compare the approach of fee-only, independent advisors.

All 401(k)s Aren't Created Equal

The Department of Labor is on a mission to improve retirement opportunities in the U.S.  This is sort of a closing-the-barn-door-after-the-chickens-have-gotten-out initiative; but at least it is useful going forward, at least in my view.

Today we are on the verge of the so-called gray tsunami wave of baby boomer retirements. And. many baby boomers aren't positioned financially to retire. They were given control of their retirement assets as companies moved from defined benefit plans that provided a pension to direct contribution plans like 401(k)s, where workers were responsible for deciding how much to invest and how to invest it.

Workers didn't save and invest nearly enough. This, of course, is the story du jour.

Looking ahead, the Department of Labor has cracked down on defined contribution retirement plan providers by emphasizing the need to offer appropriate investment choices and opt-out provisions that automatically enroll new employees unless they opt out, by increasing participation rates, and by requiring plans to disclose all costs in a manner that participants can actually understand.

It will be interesting to see how the latter requirement is implemented. Disclosing costs in the investment business reminds one of a diner choking on a turkey bone. There may be ample opportunity to practice our Heimlich maneuver.

In previous posts, I have discussed the BrightScope site that rates 401(k) plans relative to their peers. They have recently updated data through the end of 2009 from Form 5500 for many of the plans they follow. If you haven't checked your company plan rating in a while, you may want to bring it up.

Participants can use this data in a couple of ways. If, say, their plan's investment menu is rated "poor" relative to its peers, participants should ask the plan administrator (human resources) why. This goes for the other categories as well. In fact, if the participation rate is low, the head of the company should be asking why before the Department of Labor pops in and pops the question.

Secondly, as I have posted before, a married working couple should compare each other's plans. One may have a superior plan and that should be maxed out, after the match is taken advantage of. In some cases it will make sense to forego the company plan and open a traditional IRA or Roth on the side. From a longer term perspective, putting retirement savings in the right place makes a big difference.

Do You Have a Good 401(k) ?

Many times a couple has to decide the best place to make their retirement fund contributions - in the husband's or wife's 401k or an IRA? And the answer depends on the quality of the plans, company matches, etc. To help answer this question, BrightScope provides an online 401k rating service as described in this Yahoo! article: "How Good Is Your Company's 401(k ) Plan?" by Carla Fried. BrightScope examines fund costs, investment choices, company generosity as well as other key features relative to a peer group. For each peer group, it shows a comparison relative to the best, worst, and average plans.

Generally, a couple will first want to make contributions to take advantage of the company match. After that, they may consider, if feasible, contributing to IRAs and taking advantage of low-cost index funds. Finally, they can max out on the better 401k plan, etc.

It should be stressed that it is easy to get a plan rated. Plan administrators just need to get readily available documents to BrightScope. Carla Fried lists the steps a plan can take to improve their plan and what participants can do in the meantime.

How Does Your 401(k) Measure Up?

Analyzing a 401(k)

Readers of this blog know that one of the main messages is that the financial services industry has a strong tendency to grossly overcharge for its services. The industry takes advantage of the gullible public that refuses to educate itself on how much it costs to get professional money management services. The bottom line is that a big part of workers' nest eggs are lining the pockets of fat cat advisors. Nowhere is this more prevalent than in 401(k)s. But how can you assess your 401(k)?

Brightscope

An important resource to check is to go to www.brightscope.com. Put in your company name. If you are fortunate, your company 401(k) is rated. If it isn't, you may want to consider asking your human resources department why it isn't.

CLICK IMAGE TO ENLARGE. As you can see, there are a number of categories rated. Of interest in this plan is the "Investment Menu Quality" rating of "poor."

If you go a step further and complete the free registration, you get even more detailed information. You can actually put in specific information to see the true cost to you, the participant, in the plan.

CLICK TO ENLARGE. If you drill down, you can find costs for the portfolio and the costs of funds in your peer group that have superior investment choices. With the information provided by this service, there are explicit steps that can be taken to improve one of the most important benefits provided to workers. It is an excellent resource to lead to the right questions for employees to ask.

This is also a useful resource if you are wrestling, à la Mickey Rourke, with whether you should roll over your old company 401(k).