By Dr. James M. Dahle, WCI Founder

I received this in my email inbox a few years ago from a fan of actively managed investments and stock-picking.

“While I think you are right that most people should be in index funds, you are not helping people who have bad 401(k) plans where the index funds charge really high fees or are not existent. You should have some advice on how to pick an actively managed fund, as well. Most people go for the funds with the highest stars, and that is a big mistake. Essentially, even if you believe active management is a waste of time, for some people that is the only option, and you are doing them a disservice.”

Essentially, this reader is asking what to do with a crummy 401(k), not how best to pick an actively managed fund. Many people get excited when they first start learning about smart mutual fund investing and then go take a look at their employer-sponsored plans. The excitement rapidly wears off as they realize that their 401(k) plan has high fees and is filled with high expense ratio actively managed funds.

Although I have never had what I would call a crummy 401(k), I have also never received a match from any employer. Every dollar in my retirement accounts is a dollar I elected not to spend, a dollar that would have gone to pay taxes, or a dollar that those dollars earned.

At any rate, here's what you should do with a crummy 401(k).


8 Things You Can Do with a Bad 401(k)


#1 Look at the Retirement Plan Before You Take the Job

Before you take a job, take a look at the 401(k) or other retirement plans being offered by the employer. One of the best parts of being self-employed is that you get to pick the retirement plans. Then, if your retirement plan sucks, you only have yourself to blame. Plus, most self-employed retirement plans have much higher contribution limits. But if your specialty or life situation calls for employment, at least look at the retirement plans before taking the job—if for no other reason than to avoid surprises.

If two jobs are otherwise equal, you may wish to take the one with the better retirement plan. When employers start realizing that potential physician employees care about the quality of the retirement plan, they'll start caring about it, too. There are fewer and fewer crummy 401(k)s as the years go by because of this factor.

More information here:

The New WCI 401(k)


#2 Realize That Most 401(k)s Are Very Temporary

You may not have your money in a 401(k) or a similar plan for very long at all. Employers change plans, and employees change employers. Some plans even allow you to take money out of the plan without leaving the job. In one extreme circumstance, I have even seen a situation where a couple put the money into a 401(k) and then borrowed it back out to invest it elsewhere. At any rate, when the plan closes or you leave the job, you can move the money elsewhere.

In the past, the most common option was to move it to a traditional IRA where you could control the fees and investments. That may not be the best idea given the need to use Backdoor Roth IRAs, but you can always move it to a 401(k) from a previous job that you kept (a good reason not to rush out of it until you have something better to roll your money into); your new job's 401(k); or ideally, an individual 401(k). Remember, if you ever have $1 of self-employment income, you can open an individual 401(k) that you never have to close. You can eventually roll all of your employer's 401(k) money into it.


#3 401(k)s Can Be Improved

Many physicians have had success in actually lobbying their employers to get a better 401(k). The smaller your employer, the more likely your efforts are to have some effect. In small practices, your employer may be investing their money right alongside yours and simply won't realize how bad the 401(k) design is. Showing your employer how much money their decisions will cost them in the long run can be very motivating. Pointing out that a 401(k) full of actively managed funds could get them in legal trouble for neglecting their fiduciary duty may also provide motivation.

More information here:

Why Healthcare 403(b) and 401(k)s Are Being Sued for Excessive Fees


#4 Be Sure to Get the Match

It is possible that you will be better off in a taxable account than a really, really bad 401(k). But that requires you to be in the 401(k) for decades, especially if there is a match. The shorter the time period, the less effect the expenses of the bad 401(k) will have on your accumulation. If the total expenses in the 401(k) are 2% per year or less, it is almost surely worth using—and it is rare for a 401(k) to even be that bad. At any rate, be sure to put in enough to get the match. That's basically part of your salary.


#5 All Your Money Isn't in Your 401(k)

Even if you have a bad 401(k) and even if you're going to be stuck with it for a long time, take some consolation in the fact that it is unlikely that all of your retirement money is in that plan. You likely have some in your spouse's plan, Backdoor Roth IRAs, and a taxable account. The concept is to take the least bad part of the 401(k) and build your portfolio around it using the other accounts. This is also a great reason to start Roth IRAs in residency. The larger they are as a percentage of your portfolio, the less a bad 401(k) matters.


#6 Most 401(k)s Have at Least an S&P 500 Index Fund

Nearly every 401(k) lineup I have looked at in the last few years had at least a single index fund, usually of the S&P 500 variety. Often, the expense ratio was higher than you would like (0.5%-1% per year), but at least it was an option—and in that sort of a plan, it is usually still the lowest cost fund in the plan. If you have a reasonably good index fund in your plan, use that and build around it with your Roth IRAs and taxable account. More likely, when you look closely, your 401(k) probably has acceptable funds for 2-5 asset classes. If you're lucky, it is composed entirely or almost entirely of low-cost index funds. Remember to look at your entire retirement nest egg as one big portfolio.

crummy 401(k)

More information here:

Fund Your 401(k) Now!


#7 Look for a Brokerage Option

My partnership's 401(k) has a nice lineup of low-cost funds. However, it also gives us the option (called PCRA, or Personal Choice Retirement Plan, at Schwab) to go to a brokerage window and buy anything available at the brokerage, such as low-cost Vanguard ETFs. See if something like that is an option for your 401(k). Getting your employer to add that option may be much easier than revamping the whole plan. That way, savvy but whiny investors like you can be placated while the rest of the plan participants can be herded along to the slaughter by your employer's golfing buddy that sold the plan to your employer in the first place.


#8 Choose Closet Index Funds

If you truly are one of the unlucky ones and your entire 401(k) is composed of actively managed mutual funds—and if that isn't going to change—then remember why broadly diversified index funds are successful. Index funds have low turnover, have low expenses, and track the market return. Guess what? Many actively managed mutual funds share some or all of those characteristics.

Although perhaps the best strategy for picking a winning actively managed mutual fund (i.e. one that beats its respective index fund) is to choose a manager who concentrates their best bets, your goal should be to avoid picking a losing actively managed mutual fund. If the fund holds hundreds of stocks, has reasonably low expenses and turnover, and has a long track record of more or less doing what the market has done, that's a reasonable pick.

Let me give you an example, such as Vanguard's Windsor Fund. Let's compare it to a similar index fund, the Vanguard Value Index Fund. Both funds invest in Large Value Stocks. Both funds have fairly low expenses (0.30% and 0.05%, respectively). Both hold lots of stocks (125 vs. 342.) And guess what? The returns are pretty darn similar over the long haul. As of the end of February 2023, the 10-year returns on Windsor are 11.70% compared to the index fund's 11.53%. What do we call that? A closet index fund.

What you do not want to do is choose a fund purely based on past performance, especially recent past performance. You also don't want to choose a fund using the Morningstar star system. In fact, the most reliable predictor of future fund performance is the expense ratio.


An Example

Consider an investor who has 50% of their money in their 401(k), 25% in their personal and spousal Roth IRAs, and 25% in a taxable account. Their desired asset allocation is:

  • 30% US Total Market Stocks
  • 10% Small Value Stocks
  • 5% REITs
  • 15% International Stocks
  • 40% Bonds
WCICON24 EarlyBird

The 401(k) has an S&P 500 index fund with an expense ratio of 0.6%, a bond fund with an expense ratio of 1% and a reasonable track record, and a bunch of random actively managed funds with ERs of 1.5%+. What do you do? Well, here is one option (there are others too, especially if your goal is to keep your bonds mostly in taxable, a different and far more complicated discussion.)

  • 401(k): 50% of total
    • 30% S&P 500 Index Fund
    • 20% Bond Fund
  • Roth IRAs: 25% of total
    • 10% Small Value Fund
    • 5% REIT Fund
    • 10% Low-Cost Bond Index Fund (perhaps TIPS)
  • Taxable: 25% of total
    • 15% Total International Index Fund
    • 10% Muni Bond Fund

This investor has achieved their target asset allocation while minimizing the effects of their crummy 401(k). Now, they just need to get some 1099 income so they can open an individual 401(k) and get that money out of the lousy 401(k) as soon as possible.


If you need extra help with planning for retirement or have
questions about the best way to save your money in tax-protected accounts, hire a WCI-vetted professional to help you figure it out.


What do you think? Do you have a lousy 401(k)? What have you done to minimize the damage? Knowing what you know now, would you take a job with a lousy 401(k)?

[This updated post was originally published in 2016.]