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Why don’t more 401(k) plans include index funds?
This weekend, the Boston Globe had an article on a change made to 401(k) investment plans during the Bush administration. The change enabled businesses to automatically enroll employees in the retirement plan — employees would have to take action to opt-out. In addition, if the individual didn’t specify how to invest the funds, they would automatically be invested in stock-heavy funds. The Globe article estimates that 1-2 million workers were affected by the new law, and of course with the markets in a free fall, these employees have lost much of their initial investment.
This origin of this change was the Pension Protection Act of 2006. The Act changed many things about pensions and retirement accounts, including creating the default opt-in for 401(k)’s. It would seem to be a good idea — to give a bit of a push to those folks who are reluctant to fund their retirement accounts, presumably out of procrastination or trepidation. The default investment was determined by “Section 624(a) of the Pension Protection Act directed that such regulations provide guidance on the appropriateness of designating default investments that include a mix of asset classes consistent with capital preservation or long-term capital appreciation…” In other words, the default was a conservative investment. Fast forward to December 10, 2008 and the swift pen of the Joint Committee on Taxation, p. 12, relieved the restriction on default investments. Hmmm… that was about 41 days before Obama took the reigns. D’ya think maybe there was just a wee bit of lobbying going on by the investment powerhouses?
I searched, but did not find the reference to requiring companies to make investments on behalf of employees in stocks instead of more conservative alternatives. I would be interested to find the source for the Boston Globe’s article. But it’s easy to see that if an investment company is allowed to direct the investments, they are probably going to choose a stock fund, with its higher expenses, over a simple money market fund, CD, or bond fund.
Which made me think, hey… with all this talk about investment choices, why don’t more 401(k) plans offer index funds? They have much lower expense ratios and generally better track records than managed funds, if you consider the return after expenses. My employer’s 401(k) plan offers two index funds as a part of 27 investment options. While asset class is certainly important, doesn’t expense ratio deserve equal footing? And while big brother was demonstrating his concern for us, why not make the expense ratio one of the criteria for choosing the default investment.
Let me know. Does your employer include index funds in your 401(k) plan?
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Our employer does include index funds in our 401K plan choices. Until a few years ago, our 401K was totally voluntary and employees were not automatically invested. When I first started with another employer it was actually difficult to manage to get started investing in the 401K. But now new employees are automatically invested at, I think, 1% and they have to opt-out.
We can choose from 12 investment choices (and allocate in any percentage we want). These include some Vanguard Index funds/both stock and bond. We also have the option to use our 401K to open a personal choice retirement account (PCRA) at Schwab which means that we have all those funds/stocks options open to us.
My employer offers a target retirement fund that invests in indexes but beyond that we have none. It’s a shame to say the least. They do it because they can force you into more profitable funds. 401(k)s are like mini-monopolies. This is why I advise friends to max out to get a company match and the go to an IRA.
Debra: That sounds like a pretty decent plan. In general, I’m skeptical of 401(k) plans — some of the places I’ve worked only offered really obscure, poorly-rated funds, and I bet that somehow, either my employer or the benefits manager was getting a kickback for choosing those particular stocks. My current employer isn’t too bad, though I plan to calculate the average Morningstar rating for the plan’s fund offerings.
Weak: I like target funds for folks ’cause it makes it simple for folks starting out. Sometimes they are difficult to find their true expense ratios, since they are funds of funds. And I totally agree with you about switching to an IRA after contributing to your employer’s match. Thanks for your comment. ‘Like your blog, too. Good luck in Grad School (or was that just April Fools?)
http://www.affinefinancial.com/2009/02/27/should-i-fund-my-401k-or-ira/
Helen – I agree that it’s a good plan. At the same time, I actually only invest monthly IRA because I believe that to be a better tax situation for me (or will be in 25 years). My employer doesn’t offer any match on a 401K because we also have a separate pension fund which has the match calculated into it. So I’d really only go with the 401K if I maxed the Roth. When I first started working, I used the 401K so it’s still there though.
Mostly, I like the setup of the 401K and I’m impressed at the opt-out requirement because I think most beginning employees don’t get enough guidance about starting their retirement savings early.
Excellent points, Helen, and great reasons to bug your congressmen about the proposed legislation on fee disclosure and requirement of indexes as alternatives.
I can’t seem to locate the text – but I believe the proposed legislation calls for *either* a stock index, a bond index, or a balanced index. It’s a start, anyhow.
jb
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