Retire earlier with these EASY 401k plan changes
by John Ferraro, CIO of Longhouse Wealth Management
In the Beginning
Do you remember the first time you logged in to your companies 401K Plan account?
I’m sure you were excited with the possibility of saving for your retirement.
Plus, your employer was going to MATCH a percentage of your contributions.
It seemed too good to be true, getting free money to invest for retirement!
Then as you navigated around the 401k website you found the list of available choices to invest in.
Eventually, it hit you that you didn’t have the experience or knowledge required to pick from that long list of choices...
Your questions were most likely:
What are the most important things to consider when choosing what to invest in?
Are there any websites that can help me evaluate these choices?
How much should I put in the market?
How much should I put in bonds?
Should I invest in international stuff?
Let’s start with the the most important things to consider when selecting 401k choices to invest in:
That’s right expenses come first, not performance.
Most beginner investors think of performance first and expenses next or not at all.
Your 401k plan is a long term investment vehicle.
You want to reduce headwinds to your profitability as a first priority.
Your 401k plan is probably limiting you to mostly mutual funds or CITs(Collective Investment Trusts)to invest in.
The reason is the 401k administrator, the company with the logo when you log in, is revenue sharing with the Mutual Fund and CIT companies the expense ratios you're paying.
The Mutual fund and CIT choices usually come with expensive expense Ratios.
The "Executive" Choice
Here’s the thing I always look for.
They usually have a few good choices available for upper management to choose from.
That’s one of the ways the 401k administrator sells their services to the bigger companies.
These I call these the executive choices.
Your job is to find them.
You’ll have to examine the entire list but there’s usually one stock market and one bond choice with low expense ratios.
The 401k administrator companies do this because they know the majority of the employees will not search out the lowest cost choices and just pick a basketful of choices without any investment knowledge.
Now this scenario is usually for large companies with some leverage with the 401k administrator company.
For small companies , there is a good chance there won’t be any of these “Executive Choices”.
In that case just pick assets with the lowest expense ratios.
Remember the Investment Industry is built and funded on by passing on Expense Ratios to investors.
It accounts for billions of dollars in yearly revenue and the funny thing is, most investors in 401k plans don’t pay any attention to it.
They're focused on the free money aspect of the companies 401k match, so it looks like it doesn’t really matter.
This is a big mistake you don’t want to make.
1.a Expense Ratio
This is the big one to focus on... many mutual funds expense ratios are in excess of 1.0.
That’s 100 dollars per ten thousand per year to own the asset.
That may not seem like a lot but on a million dollars, it’s $10,000/year.
You see how it adds up...
On a Billion a year, it’s $10 Million
There are many low cost ETFs (Exchange Traded Funds) that have expense ratios of as low as .04.
That’s 4 dollars per $10,000 invested.
Notice those types of assets are rarely, if ever made available in your 401k Plan to invest in because, nobody makes any money off of you using them.
1.b Load or No Load Charges
This is more of the expenses you want to avoid at all costs.
In no case would I sign up for a Mutual Funds with either front (Schedule A) or backend (Schedule B) sales charges (loads).
The yearly sales charge or expense ratio is the Schedule C charges that you can’t avoid, but can minimize with a little searching.
1.c 12b-1 Charges
These are sales and marketing costs the Mutual Funds company charges you.
It's usually .25% and pays them to the advisor, 401k administrator or whoever pulled your money into the mutual fund investment.
Avoid that charge at all times.
2. Ratings Websites
There are multiple rating websites that you simply enter the mutual fund symbol and it rates them for you.
One thing to watch out for is, if the service is taking payments from the Mutual Fund company to elevate their rating.
I have found fund ratings suspiciously higher than their expenses and performance would rate.
So use them, but double check the expense and performance versus peers data.
One of my favorite free mutual fund evaluation sites is Maxfunds.com.
Quick and easy to use, they rarely give a rating that doesn’t make sense.
Anything rated less than 90 I would be hesitant to select.
Morningstar and Zacks are also widely used but after a few checks they usually try to find a way to start charging you.
Be very wary of the mutual fund companies themselves giving you free rating of their investment products for obvious reasons.
If you have a brokerage account, many have screeners that you can use to sort based on expense ratios and performance.
Those can normally be trusted to give you accurate information.
An educated investor is always in a better position to make a smart investment.
By learning a little about the industry and how they charge you for their services, you'll ultimately save in the long run.
Hopefully, you'll be able to retire earlier by paying less in unneccessary fees.