I’ve written before about my 401K. Every quarter or so I get this really detailed 401K statement from our 401K administrator which cracks me up because it is such good evidence of the folly of choosing actively managed funds and performance chasing. There’s a few other little quirks that just make me shake my head too.
Overall, it isn’t too bad as a 401K. The fees aren’t that much, the ERs are high, but not ridiculous, there’s at least one very low cost index fund I can build around, and there’s a brokerage option that allows me to buy anything (although there is a $200 annual fee for that option.) I’ve definitely seen much worse 401Ks. But it does make me miss the TSP I had in the military, where everything was ultra-low cost, there were no additional fees, screw-ups with contributions were unusual, and there were 4 great index funds and the free-lunch G fund.
So, change # 1 to my 401K this year is that they’re phasing out the stable value fund. This isn’t the 401K plan administrator’s fault, it’s just that Charles Schwab has decided to liquidate the fund. This is really too bad, because these funds are often great choices in a 401K. They’re kind of similar to the TSP G fund. It’s not exactly clear why Schwab is getting out of the stable value fund business, as it is seems more profitable than it was just a couple of years ago at the height of the financial crisis. Stable value funds are way better right now than a money market fund (which are paying basically 0% right now.) So my 401K is substituting the stable value fund for a money market fund. Thanks guys, way to hook us up. You couldn’t find another stable value fund outside of Schwab, or at least a decent bond index fund to exchange it for in the plan?
Change # 2 to my 401K is that the administrator has decided to fold the Growth Fund of America into the Schwab Total Stock Market Index Fund. The administrator’s philosophy is that he can choose the good mutual fund companies and avoid the bad ones. He does this primarily through past performance data. So now that the Growth Fund of America has been doing relatively poorly, he decided to drop it. He apparently also just realized that the GFA has been a high-cost closet index fund for years. What a surprise.
I find it fascinating that the administrator continues to chase performance like this. The data that it doesn’t work is clearly right in front of him (since he sends it to me each quarter.) He ranks each fund in the plan against its peers. Of the ten funds in the plan last year, 5 did better than their peers on average, and 5 did worse. The 3 year and 5 year data looks exactly the same. My 401K money is entirely in the Schwab Total Stock Market Index Fund (which beat 72% of its peers in the last year, 85% in the last 3 years, and 80% in the last 5 years.) That’s better than all of the chosen actively managed funds have done. Obviously I have other retirement accounts (including that old TSP), so I haven’t had to use any of the other funds in the 401K yet. I probably won’t. Once the amount in the 401K is more than my allocation to TSM, I’ll probably avail myself of the brokerage option (or perhaps get on the 401K committee and try to make some real changes.)
The other interesting thing about this quarterly statement is that they compare all of the 401K participants (anonymously) to each other. The company is basically 100 emergency doctors and a few other employees. By doing nothing but put all my money into the only index fund in the plan, my investment returns are better than 72% of those at my company. Why the administrator feels this is a relevant fact to share is beyond me. I’m not sure trying to institute some competition is the best approach to running a 401K. Reporting that data probably does, however, encourage plan participants to performance chase and time the market. In fact, the paperwork accompanying the statement encourages you to come meet with the advisor if you were in the bottom 40% of the company. Never mind that most of the doctors in this plan have other retirement assets, are different ages, have different risk profiles etc. In fact, it’s likely that the 28% of plan participants that had higher returns than I did last year were invested entirely in the now-discontinued stable value fund and/or the seriously-underperforming PIMCO Total Return Bond Fund.
The best part of the form however is this statement:
How do you know your risk tolerance? If you always drive at or below the speed limit you are conservative. If you like driving 80 miles per hour (which, ironically, is the speed limit on the interstates around here), you are aggressive. If you’re somewhere in between, you’re moderate.
Seriously, if that’s how you decide on your asset allocation, you need some serious financial education.
Have you looked at your 401K statements and the paperwork accompanying them? You may be in for a shock to realize just how financially unsophisticated those running your 401K are.
Photo Credit: Charlie Cowins, CC-BY, Wikimedia
White coat investor,
My 401k is also thru Schwab and there is a “finacial advisor” who helps the company pick out the mutual funds in it. I am curious as to the amount of other fees you pay in addition to the underlying mutual fund expense ratio
My 401K has fees for “administrative costs”, “investment advisor fees”.
My lowest cost index fund ( schwab 500 index has a ER of 7 basis points) but the other fees addup to about 20 basis points)
My additional fees are labeled:
Accounting/Misc Service Fee (once a quarter) $24-26
and
Recordkeeping Fee (once a quarter) $24-26
They seem to be flat fees, as they aren’t going up as the assets in the account go up. That’s $200 a year though. The “brokerage option” that allows me to buy anything instead of the Schwab TSM fund and the crappy active funds the advisor has picked costs $200 a year. I wonder if these other two fees go away if I just move everything into the brokerage option. I suspect not.
I’m 100% TSM in the account now at 0.07, but if I add in that $200 a year in expenses, that would increase my total ER to 43 basis points, or 0.43%. Gotta love Wall Street. Everyone wants their cut. I can’t figure out why it costs $100 a year for recordkeeping, but then again most people can’t figure out why an aspirin in the hospital costs $32.
I found your comments regarding the Stable Value Fund switch intriguing because our plan went through the same decision process and chose a money market fund instead of another stable value fund. The reason our plan switched to the money market fund is because the stable value fund was becoming increasingly risky and in the event that interest rates whipsawed higher, the risk of this fund actually losing money was heightened. Because stable value funds invest in money market instruments as well as short term bonds, these type of funds are often mistakenly assumed to be principal preservation funds. However, if you own a bond that you purchased for $1,000 that pays 2% and matures in 3 years, the market value of that bond is $1,000 as long as rates stay at 2%. However, if market rates jump to 3%, the market value of that bond (ignoring yield to maturity and other market conditions) would fall to $667 in order to yield a market rate of 3%. Now obviously an individual would hold the bond until maturity but funds don’t have that luxury. Funds have to update their values daily so while there was a 1 percent jump in interest rates, the value of the bond dropped 33%! Of course, if interest rates dropped to 1%, the underlying value of the bond would jump to $1500, a gain of 50%! However, because the likelihood of further interest rate drops was diminishing and the likely course of interest rate direction was upward, our management committee felt that the risk was just too great and the switch to a money market fund was appropriate.
I got a letter in the mail last month from my 401(k) administrator saying that they were swapping one actively managed fund for another one and I laughed. I didn’t have any money in that fund, plus I found it hilarious that they were switching one active one for another one from a different company. I’m just glad that they didn’t switch out any of my index funds (S&P 500, Total International Stock, Total Bond Market) or my stable value fund.
I can’t believe that they would compare the investors to each other! That’s crazy. Doesn’t that violate people’s privacy with the small size of the data set?
schwab doesnt have many index funds. i think there are 5. would u buy vanguard stuff through schwab or just purchase some of their etfs?
Chris
Don’t think your math is right. You won’t lose 33% of bond value with a1% interest rate increase for such a short duration bond.
TSP is a great product. Too bad no matching for uniformed service members.
I doubt tsp will include matching as long as the military pension system exists. It’s a shame since it penalizes people who serve a few years but don’t stay until retirement.
I would think that a silf-directed plan would overcome all the limitations of your current plan.
Anon-
Yes, the self-directed option has only one downside- the $200 fee. But the 401K company has to be compensated somehow for running the plan, and I’m more than willing to pay a flat fee. Would I like a lower fee? Of course. My favorite price is free, but I don’t get much for it usually.
Pete and Rex-
I agree. A match would be nice for the military folks. Not sure which would be better overall, the pension or a matched 401K. Probably the pension, as it keeps a lot of people in until 20 years. A matched 401K would encourage people to leave (although probably not as much as the deployments.)
Leigh-
You think HIPPA applies somewhere besides hospitals? 🙂 No, I don’t think there’s a privacy issue. I find it interesting. Not very useful and possibly harmful if it encourages performance-chasing, but interesting.
Mark and Chris-
Mark’s right about the math. This is the purpose of “duration.” Duration measures the sensitivity of a fund to changes in interest rates. A fund which holds bonds with an average maturity of 21 years (such as Vanguard’s long-term treasury fund) has a duration of about 15 years. That means if interest rates go up 1%, you’ll lose about 15% of your principle. Most bond funds have durations of around 5 years. So, while rising rates can hurt your returns, they’d have to go up pretty far, pretty fast, to really penalize bond investors. You’d have to have a seriously long duration to lose 1/3 of your principle, and I don’t think any Stable Value funds deal with bonds with durations like that.
I do agree that Stable Value funds are riskier than many people think they are (there is more risk than with a money market fund), and there were some issues in the recent bear market with stable value funds. But I think there is still a role for them in 401Ks.
Rex-
I haven’t looked at the commissions for buying Vanguard funds through Schwab. I’m looking now.
Looks like Schwab ETFs can be bought and sold without commission. They’ve got a REIT ETF with a similar ER to Vanguard’s REIT ETF. They have a TIPS fund and a TBM fund that aren’t too bad. Doesn’t look like Vanguard funds are on their no-fee list, but I could buy/sell ETFs for $9 a trade. I can’t quite figure out what they’d charge me to buy an actual Vanguard fund, but I don’t see why it would be less than $25 a buy. I’ve been thinking about moving my EM and Small Intl holdings into ETFs anyway to avoid the Vanguard buy/sell fees, so that’s probably where I’ll start in the 401K.
Jim,
I don’t follow your logic on why a matched TSP/401K would cause people to leave the military. It seems to me that it would only (slightly) sweeten the deal to stay in. Though I think it would be only a small influence in the face of deployments, etc, as you allude.
I think the fixed annuity-style pension works well for the military, because many service members lack the financial education/discipline to maximize contributions to a 401K and/or plan for their own retirement.
I’m saying if the retirement was only a matched TSP instead of a pension, not a matched TSP plus the pension.
I don’t think service members are any less financially sophisticated/disciplined than anyone else. But that isn’t saying much.
Chris is wrong about the 33% loss. More likely to be a 2% to 3% loss.