Why do so many 401(k) plans choose terrible investments when they have the ability to choose good ones? Research suggests that lower-cost funds mostly outperform higher-cost funds over the long run. I helped a client reallocate their portfolio and was disappointed to see that their 401(k) plan only offered one high-cost fund in the mid-cap stock category while they separately offer a low-cost index fund in the small-cap category. The mid-cap stock fund that they offer has underperformed a low-cost, mid-cap index fund by over 4-1/2 percentage points per year over the last three years and by over 3 percentage points per year over the last five years. If they offer a small-cap index fund then they must be able to offer a mid-cap index fund but they chose not to. It would be understandable if they chose to offer a fund that has been outperforming its benchmark but not one doing poorly. Perhaps they selected it right after it had a few good years. If this is the case, they may not know that many funds which do well one year do not do well the next. This is not an isolated case as I so frequently see retirement plans that only offer underperforming, high-cost funds. When you buy an index fund, you know you will match the market. When you buy an actively-managed fund with higher internal fees, you never really know what you will get because it is up to the decisions of the manager. In the case of the mid-cap fund in this 401(k) plan, the manager made bad decisions and the fund investors have lost quite a bit of money over the last several years because of it. 401(k) plans have many legal protections for retirement savers. But the legal protections don’t prevent the selection of poor funds that too often cost the investor money.
(Past performance may not be an indicator of what to expect in the future and your individual circumstances should be considered in any investment decision.)
Larry Pike, CFA
Client Priority
Financial Advisors LLC
www.clientpriority.com
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