Are These 4 Big Risks Hiding in Your 401(k) Plan?
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A 401(k) plan is one of the best vehicles for helping you save up for a secure retirement, but a second proposed class action lawsuit being filed against brokerage firm Edward Jones highlights once again that even the best savings plans can hide significant risks. Do yourself a favor and ensure that your own 401(k) doesn't contain these hidden dangers.
Nickel-and-dimed to death
According to Investment News, the lawsuits against Edward Jones involve similar allegations that the brokerage forced plan participants to pay high fees for investment and record-keeping services. The plaintiffs also allege that Edward Jones failed to offer low-cost mutual fund alternatives to the high-cost funds directed by the brokerage's partners. With almost 36,000 participants and over $3.9 billion in assets, Edward Jones plans are alleged to have lost $13 million in retirement savings to excessive fees.
The latest lawsuit alleges that Edward Jones' plans offer certain mutual funds primarily because they have a revenue-sharing agreement with the brokerage. It says 80% of the plans' assets were in mutual funds that share revenue with Edward Jones, and half of the plans' assets were in those that paid the most.
Edward Jones isn't the only brokerage that's being sued for breaching its fiduciary duty through its retirement plans. Morgan Stanley was just hit with a lawsuit, as were financial services firms including American Century Investments, Franklin Templeton, Neuberger Berman, and New York Life Insurance.
Two for me, one for you
While Investment News characterizes many of the allegations as unique to Edward Jones, there are still things you should be looking for in your own 401(k) plan to make sure you're getting your money's worth. For example, excessive fees are a hidden drag on your investment returns. If your investments' expense ratios exceed 0.50%, then you should investigate whether that cost is justified. If they're above 1%, then that's a major red flag, and you should seriously consider alternative investments.
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Since the end of the year is often when investors take stock of their portfolios with an eye toward rebalancing them, it's probably a good idea to review your plan and see if it has any of these four hidden risks.
1. Does your plan have potential conflicts of interest?At the heart of the lawsuit against Edward Jones is the charge that the plans' policies were dictated first by the amount of money the brokerage would generate from its partners. The suit alleges that of the $770 million in profits the brokerage reported in 2014, $153 million came from mutual fund revenue-sharing.Because mutual fund returns are reported net of fees, the charge is often hidden from investors, though it lowers the overall return of the funds.
While any plan provider and investments offered should be chosen on their merits, according to Edward Jones' revenue sharing disclosure statement, its revenue sharing agreement with its partners creates "potential conflict[s] of interest in the form of an additional financial incentive and financial benefit to the firm, its financial advisors and equity owners." You should investigate whether your investments present any conflicts of interest such as revenue sharing and decide whether they're worth the risk.
2. Are you paying unnecessary fees?Edward Jones allegedly offered high-cost mutual funds even though low-cost alternatives existed from the same fund family, leading to more than $13 million in excess plan costs. For example, the brokerage offered participants the Lord Abbett Bond Debenture (LBNYX)fund, the fee for which was 0.62% of the $88.4 million in plan assets, even though Lord Abbett offered a similar bond debenture fund (LBNVX) with fees of just 0.53%.
Further, plans may offer funds that charge 12b-1 fees, or charges paid toproviders for distributing a product on their platform or for performing certain administrative services. While 12b-1 fees may have once been a necessary or useful compensation incentiveto offer non-proprietary mutual funds when the vendors were primarily providing arecord keeping function, they have long since fallen out of favor and make for a high-cost option in a plan.
According toa report issued by Deloitte Consulting and the Investment Company Institute,the average participant in a 401(k) plan paid annual fees amounting to 0.67% of assets, although that did vary by the size of the assets managed by the plan.
To combat such costs, index funds are a viable option for the vast majority of investors, providing a low-cost option for your portfolio. Many broad stock-market index funds charge annual fees of less than 0.20%, so check to see whether your plan offers any.
Keep in mind one important caveat: Though you should always seek to minimize the fees you pay, it's possible that if your employer offers a generous match on your contributions, it may offset otherwise higher fees the plan charges.
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3. Are there only money market funds available for cash?Money market accounts are poor options these days for parking your cash. Because of fees and inflation, the value of your money will steadily decline while it's in a money market account. Because Edward Jones allegedly failed to offer participants cash preservation options -- for example, a stable-value fund that uses insurance contracts on pooled accounts of bonds and other fixed-income investments to provide a specified rate of return over periods of time -- plan participants in the brokerage's most conservative MMA options "lost over 12% of their buying power."
Check to see what options your plan offers for your cash. Although cash can be used as a hedge against volatility, young people in particular generally shouldn't have large percentages of their portfolio stashed there, and even older investors want to ensure their cash balances aren't being destroyed by inflation and fees.
4. Is there a limited variety of asset classes?While Edward Jones isn't being sued for a lack of variety in its 401(k) plans' investment options, make sure your own plan is giving you enough choices. You don't want to overindulge in company stock, for example, and you should have exposure to several different asset classes, including large-cap and small-cap U.S. stocks, international companies, and even bonds. And you want to be able to diversify as cheaply as possible (see note on index funds above).
Knowledge is power
So you know what to look for -- now where do you start? Begin by reviewingyour account statement, the disclosure forms that plans are required to provide participants, and the plan's annual report.Becausefees come in various forms, finding them isn't always easy, so you might try comparing your plan to others on a site like BrightScopeand/or searching the U.S. Department of Labor'sForm 5500 for plan disclosures.
If you've looked over your plan and found it contains one or more of the above risks, then you can approach your employer, whether in person or in writing, and present your findings. Propose that your plan administrator seek lower-cost investments or even alternative plans. It may be as simple as requesting that index funds be offered if they aren't already.
When you encounter conflicts of interest or sweetheart deals, stronger action might be required, whether it's a call to the Labor Department or, as was the case with Edward Jones, legal avenues.
When it comes to investing, there are always risks, but knowing the dangers ahead of time allows you to go in with your eyes wide open, and it may prevent you from getting blindsided by unseen hazards.
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Rich Duprey has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.