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:
#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.
More information here:
#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
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.]
Practical article. Only thing I would say is that I would avoid a hypothetical bond fund with a 1% ER altogether and put all of the 401k in the S&P fund.
+1
Let’s say you have a 401k with a total bond fund with a 1.05% ER and a total stock fund with a 1.05% ER. You also have a taxable account with a total bond fund with a 0.05% ER and a total stock fund with a 0.05% ER. Whether you go with the stock fund or the bond fund in the 401k, you’re still paying an extra 1% ER over the comparable funds in the taxable account. Mathematically, does it make any difference whether you invest in the bond fund or the stock fund in the 401k assuming a constant asset allocation across all accounts? You’re still paying the extra 1% regardless.
I would chose a better bond fund with a much lower expense ratio.
There is no better bond fund. We’re talking about a crummy 401k.
I really want to know though- is there any mathematical difference between the two scenarios?
So many variables to me that matter to me that you didn’t give so I chose my own. First, asset placement matters, so I don’t agree with the constant allocation restriction in your example. This is how I think about it and did it:
1. When young, placed stocks in tax advantaged. Didn’t worry too much about expense ratio because they change over time as do your options. In taxable, built up cash to meet liquidity needs. When had enough cash, went to bond fund for its stability. Taxable was better than muni back then for us.
2. As age and assets grew, changed bond fund in taxable to balanced fund.
3. As age and assets grew, changed balanced fund to stock ETF and moved all bonds into tax advantaged.
I’ll let someone else play with your hypotheticals. I am better in the real world:)
This is not a hypothetical. I work for a practice that has a lousy 401k, and the only funds worth investing in are Vanguard Total Stock and a Total Bond index fund from Dreyfus. We don’t even have an index fund that covers international. The expense ratios for both funds are exactly 1% higher than their corresponding funds in either my taxable account and Roth.
I have a sizable taxable account which is all stocks at the moment. My Roth is all stocks. My 15% bond allocation is entirely within my 401k. I don’t see any mathematical difference in overall growth of my portfolio as a whole between putting bonds in either taxable vs 401k since I’m paying an extra 1% on my 401k account regardless of which fund I am invested in.
Regarding point number 2, I thought it was not wise to have a balanced fund in a taxable account due to the tax inefficiency of such funds. One could use municipal bonds, though they are not nearly the same thing in regard to risk as either a total bond fund or treasuries.
See my answer to Beginning Investor below. Hope it helps!
GK-Another thought…
Try posting your specific info and question over on the Bogleheads site. Be sure and use their preferred format which I find a little confusing but at least it is standardized. It will force you to add a lot of the variables missing for me. Often the whole process seems to help the person answer their own question. You will get a lot of different opinions on your individual situation. In the end it usually comes down to the best personal behavioral answer of the mathematical choices.
The process of asking the question properly is key, absolutely. Maybe I should put those directions on to our forum here. You may get fewer answers (although those questions don’t usually get a lot of answers on Bogleheads) but they’ll all be from high-income professionals.
Dr. Mom, if you are still reading this thread, what was your reasoning for keeping the bond fund in taxable first, and later in tax-advantaged? Did you initially thought you would need to use it in a few years and wanted a less risky investment that was accessible without tax penalties, or is there a strategy behind switching the location of assets when getting closer to retirement? Thank you in advance for the info!
Sure. I put bonds in taxable initially because I valued stability of principal in taxable when we were younger. When we were starting out with lots of student loan debt, young kids, a new diagnosis of IDDM in my husband, and jobs that weren’t seeming so great, I valued that stability a lot. I found it easier to take risk (stocks) in retirement funds which I knew had a very long time horizon if I had access in taxable accounts to enough liquidity (emergency funds, cash for upcoming needs, etc.). My initial retirement plans had crummy stock options but I was financially ignorant then. I chose what I thought was best. The ER was well over 1% back then.
As our assets grew as we got older, I felt less need to be as risk adverse in taxable. Our jobs settled out. Kids were fine. My husband’s Type I diabetes was well controlled. For simplicity I went to a balanced fund in taxable to take on some stock to potentially have a higher return. We rolled old retirement accounts to IRA’s with much better options.
As bond yields now are so low and our assets have grown, I am fine holding more cash and no bonds in taxable along with a stock ETF for better tax efficiency. I hold the bonds in tax deferred because I see them as offering me risk reduction and rebalancing ability there. I don’t worry about their low yield there as for now it is not my purpose in holding them.
Hope my thought process helps. Holding enough cash in taxable to meet personal liquidity needs over the years has helped me weather the ups and downs of a more aggressive asset allocation in retirement accounts. The point I was trying to make with GK was that as much as I love being mathematically correct, I have found it doesn’t always give me the best answer for what behaviorally is best for me. Best wishes Beginning Investor!
Thank you so much for your answer – I think the ability to rebalance stock:bond within the tax-advantaged account without creating taxable capital gains (as opposed to rebalancing within taxable) is one that is appealing to my personal situation. I was not even thinking of that one… (Will get bonds within the next few years, now know where to put them).
Don’t overthink where to put them. If tax-advantaged makes sense to you start there. As you see from my example as time and circumstances change your portfolio changes with you.
I think the importance of Dr. Mom’s asset allocation and location is that it has changed over time as her circumstances have changed. Some of the newer investors also may not realize how much tax laws change and this really will effect your planning. I have always owned some muni bonds for stability. I plan to use the income they generate for early retirement spending with no federal tax. I have recently added bond funds from Vanguard into my SEP-IRA at the recommendation of Vanguard CFPs primarily for stability. Having bonds, stocks, and cash located in taxable accounts gives maximum flexibility as retirement approaches. When I was younger I never really had much of an emergency fund and I was lucky enough that this never mattered. I have accumulated one now.
I’d be very careful choosing a different asset allocation based on costs. I think AA is more important. For example, why not put 100% of all your investments into the lowest cost option you can find? Because you lose diversification, and some diversification is worth paying a little more for.
WCI,
Would you ever consider moving any of your individual 401k or IRA assets back to your old TSP account? The TSP’s expense ratios are much better than any other index fund I’ve ever come across.
Yes, I’ve done that when we closed our defined benefit plan this last year. I’ve also considered it for my individual 401(k). I probably won’t do it with my Roth IRA though, as I typically use that for asset classes unavailable in the TSP. Plus, the TSP has terrible withdrawal options. If those don’t change before I retire, I’ll probably move TSP money to Vanguard.
Why did you close your defined benefit plan?
To move the money into 401(k)s/IRAs and eliminate the risk of current partners being on the hook to make up for market losses for retired partners. That’s kind of the plan all along, to close it every few years and do that but you need a different reason for the IRS and that reason was some minor changes to the plan.
So will you open a new one? And, if so, how long do you wait before opening it? I never considered the idea of closing one and opening a new one as a way to get around having to make up for market losses. Seems genius. Is it kosher to do that?
Already open and funded.
As I said, you need another reason for the IRS.
But if you can find one, you get lower investment expenses, more control over investments, better distribution options, less risk of needing to fund someone else’s pension etc.
Last question (hopefully). Does the plan have to stay open some minimum time before you close it and reopen another?
I think it would look pretty bad if you closed it every year or two. I think it had been 10+ years for our plan.
The US Supreme Court has recently come down on plan sponsors (the employer not the company that sells the mutual funds) for liability for providing crummy 401k’s.
https://corpgov.law.harvard.edu/2015/06/22/supreme-court-fiduciaries-must-monitor-offered-401k-investment-alternatives/
Some great points WCI. To the readers question…Morningstar research suggests that a funds expense ratio is the ONLY factor that can be used confidently to predict a funds relative performance. So, to pick the best active fund, you’d pick the one with the lowest expense. That could have many other portfolio ramifications and probably isn’t a complete solution. And, if the index funds in the plan are expensive, it’s likely the active funds are worse.
From the employee perspective, I suggest you find the lessor of the evils in the plan and offset that with better outside holdings. Generally, that means picking the one index fund available or the closet index fund with the lowest fees and rounding out their household portfolio with outside investments, if available. Of course, you can try scaring your employer with a discussion about how they are failing to uphold their fiduciary responsibility too! (See GA’s link)
From the employer perspective, changing a plan is not overly difficult. With a little transition period and fiduciary guidance, a plan of any size can have a great, low cost fund lineup, excellent service, AND satisfy compliance and ERISA best practices through well documented processes.
I wish their was a law that allowed people to freely move money between 401Ks irrespective of their employment status.
https://www.whitecoatinvestor.com/10-reforms-that-would-improve-our-retirement-system/
In my experience, I have found that among small to mid-size employers (< 500 employees) it is the finance and HR functions that select the 401k provider. Usually, the high touch provider with lots of glossy handouts and on-site presence wins out. Its fun to watch them sweat when you point out high ERs and the absence of index funds.
WCI,
Great post, this one is very helpful for me. I have a few questions:
1 – Is it possible to roll over money from my current 401K into a prior 403B or can it only go in to 401Ks? I have a 403B with great investment options.
2 – If that doesn’t work I would think about getting a personal 401K instead. However, I thought you can only put enough money in personal 401Ks to not exceed 20 percent of your income as an independent contractor. Is that correct or does that only apply if you are trying to put more money in beyond the 18,000 limit as an “employer contribution?”
Thanks so much!
RE: #2 I’m quoting Money Magazine
solo 401k max annual contribution = 25% of profits + $18k, up to $53k.
1 — generally you cannot transfer funds from a current-employer 401k (or 403b, 401a, etc) into a different 401k (or 403b …). You can do so at separation.
2 — Rollovers (really direct transfers) don’t count against that limit, just as they don’t count against annual 401k/403b contribution limits.
1. Depends on the rules of the individual plans. But in general, upon separation you can transfer money from any 401(k)/403(b) to any 401(k)/403(b)/IRA. The IRS permits it.
2. You need self-employment income, at least a little, to open one. It’s ~20% of your SE income if you count the contribution, 25% if you don’t.
Good idea to make some lemonade here. One caveat: it isn’t always the most advantageous to transfer to an individual 401k. For control and costs it may be much better to do so, but at least some states do not provide the same asset protection for an individual 401k as for an ERISA plan. Individual 401k’s are treated as IRAs for asset protection purposes, since they do not qualify as ERISA plans and are therefore governed by state, not federal, law.
I’ve actually read up on this in the past, and here are two links on the subject, you can look up your state:
http://www.assetprotectionbook.com/forum/viewtopic.php?f=142&t=1566
http://www.irafinancialgroup.com/solo401kassetprotection.php
There is such variety of how each state treats various asset types.
I make no claims of anything in those lists being accurate or up-to-date, but I’ve used them as general guide for myself. I think to some extent unless there is a specific law that specifically addresses solo 401k’s, the decisions about asset protection may end up on case-by-case basis – probably based on case law in that state. Of course if one changes state of residence and has a sizeable solo 401k, asset protection strategies (or change thereof) is something to consider.
This is not correct. A solo 401k is a qualified plan under ERISA, so it is afforded the protection under ERISA.
I have a crummy 403b at my employer, Mutual of America. Their cheapest fund is their own index fund at 1.37% ! They have Vanguard and other Funds but all above 1.6% . Ridiculous. I kept money in Fidelity Contra fund there, which was 1.6% (nearly 1% higher than Fidelity’s own fee) but it beat MoA’s index several years at that rate. I only changed it to the Index after reviewing our total plan last year and consolidating Roths, DBP and solo-401K in Vanguard (I’m half employed, half self employed). My wife has TSP access with indeed the cheapest rates available, but as WCI said, unless they change the withdrawal options, she is not switching anything over.
My employer is now looking at a different vendor after I pressured them a lot, but I’m not holding my breath. I’m just putting enough in for the 2% match, the rest goes to the 401k.
Can you describe for others in your situation how you argued for a new plan from your employer?
After being brushed off at the clinic (“it’s difficult to negotiate or change”) I first spoke with a representative of MoA about the fees (doesnt hurt to try yourself), who explained that, when the clinic had a certain level of assets in the plan the fees would drop automatically and was told that the clinic was close to that number.” Ofcourse it didn’t happen. I went to the CFO, who had other priorities. I also worked on the CEO. Then we got another HR director, who understood and had dealt with it in another company. Ofcourse being new she could not immediately act but I kept reminding her kindly. A new CFO came on board not much later, so I approached him too. He had already seen the crummy plan and, hence, they are now just begining to ask for and reviewing bids from companies. It took 2 years and it will take likely another before we have a better plan. Never mentioned the new law (I assume they know they law) and always try to be well informed and nice, but if they had not responded the way they did I would certainly have kindly pointed out that someone might use that.
You were far kinder and gentler than I could have been. I hope others can learn from your patient persistence. Thanks for the reply!
This makes me feel good about the fact I that last weekend I finally went into my husbands 401k and dumped everything into an s+p 500 index fund. It has a low ER whereas everything else is 1% or higher and he really doesn’t pay attention to these things! Now to work on balancing it out…. Also very grateful that my employer pays for nearly all of our plan so not a ton of choices but most funds have a 0% ER and the highest is in the .3 range I think!
That would be very unusual for an employer to pay the ER.
Agreed, but you don’t get 0.01% expense ratios any other way! I kept looking and looking at it and thinking it must be a mistake, but it isn’t…
I don’t have a bad 401(k) but I do work for the state government and I have to put in 8% (pre-tax) into the state’s retirement plan. The interest rate is 2% per year on my contribution, compounded annually. I think it’s nice to have an account where the value will always increase, but I feel like the 2% is pretty low because I am at the beginning of my career. If I stay for 10 years (which I will not be doing) then they will add on 20% to the contributions, if I decide to take the money out of the account.
WCI,
I’m glad you wrote this article. Perhaps you can lend some advice to me. I am an employed physician with a 401k with my current employer. I also have a 401k from a previous employer from prior to med school. Lastly I have a TSP account from my previous job at the VA. I do annual backdoor Roth IRAs.
Do I keep things status quo or try to roll my old 401k and TSP into my current 401k (I can do that, correct?)? Or do something else? The old 401k has “meh” fund options. TSP is TSP. So I’m not sure what to do with them.
Why not at least put the old 401(k) into the TSP? If you want to simplify, you can put it all into the current plan, but I’d keep the TSP if I were you (actually, I am you and I did keep the TSP along with my current plan and my individual plan.)
Did you choose to keep the TSP due to low fees?
Yes, and the G fund.
Thanks.
First step is to understand the fees you are paying!
Go to these websites for help:
http://www.401Kfee.com/how-much-are-high-fees-costing-you
and
http://www.petersbeckhamreports.com
Please make note that the expense ratio is the fee for investment management services. The investor also pays fees for retirement plan services. The combined fees gives us a true picture of what we are really paying as investors.
Re: Tibble v. Edison International
The SCOTUS ruled last May that ERISA is violated when there are higher priced funds on the investment menu when lower priced (no-loads) are readily available. How many plans out there remain in violation of Tibble?
I apologize if this has been covered in previous posts/blogs, but I’m a little confused about 1) my best options for retirement savings account from when I was in residency, and 2) what to do with my current 401(k) profit-sharing account.
I’ve been out of residency for 4 years now, but while I was a University of California resident and they had a Defined Contribution Plan through Fidelity that accumulated about $18.8K over 5 years. At the time, I was not WCI-savvy and therefore took no active role whatsoever in managing this account, so it has been sitting in a “UC Savings Fund” plan that has yielded 1.2% over the past 5 years. I’m trying to figure what to do with this account now.
I also have a 401(k) profit-sharing plan through my current practice since I became partner in January 2015, through which I save 35K/year (22K employee, 13K match) that is still not yet invested and is sitting in a brokerage account. I met with our practice 401(k) manager and she laid out an investment plan for my 401(k) that currently has $53K that would cost me $50/trade plus a $7 mailing fee and SEC fees:
10% Treasury Bonds
20% PIMCO Short Maturity Active ETF
25% Vanguard Total Stock ETF
10% Vanguard Health Care ETF
10% Vanguard IT ETF
10% Vanguard Developed Markets ETF
10% Vanguard Consumer Discretionary ETF
So at this point, I’m undecided as to:
1) What to do with my old Fidelity UC-DCP account–leave it where it is and try to change to one of the other 27 investment plans they offer? Or try to roll it over into my existing 401(k) to simplify my accounts? Or use it to fund a “Backdoor” Roth IRA?
2) Go with my “advisors” recommendations and pay her fees or go with with the Vanguard Advisor Service (0.3% for 50K) or try to roll it into a roboadvisor type account with Betterment (at 0.25%)
I have no other retirement accounts and, as you can tell, I’m a total newbie to this. This is my first step into retirement investing and I’m hoping to become a DIY’er over time, but wanted to start somwhere.
Put it all in the Vanguard Wellington fund with its 67:33 split in stocks:bonds and forget about it because it includes automatic rebalancing. KISS=Keep It SIMPLE, STUPID!
1. I’d get away from Fidelity. Roll it to an IRA – regular or Roth depending on your situation.
2. Can you do a Vanguard Target Date Fund that would offer you more stock to bond than Vanguard Wellington and be just as simple?
3. Start reading! Research the three fund portfolio. Read The Coffeehouse Investor. Read Common Sense on Mutual Funds. Don’t decide on advisors yet if you really want to become a DIY’er. It is just not that hard. Of the choices you gave on advisors if you want one now, I would go with Vanguard Advisor Service. Good luck and happy learning!
If you are a partner in the practice, there is no reason to keep it this complex. Overhaul your plan to set up an investment menu with low cost index funds and no asset-based fees of any type. Your ERISA 3(38) fiduciary can then set up model portfolios for you (with an average expense ratio of 0.15% or so) using Vanguard and/or DFA funds. No need to use a brokerage window, which is not easy to rebalance and is generally unnecessary (and a potential fiduciary breach if your practice has any employees other than physicians/owners).
How old are you? If you are mid thirties, if your job is secure, and you have an emergency fund then I might put it all in Vanguard total stock. The complicated allocation will cost you more it sounds like. I would roll over the other money into your 401K with current employer. If you are unsure then the Vanguard advisory service is a good start. I would second Dr Moms comments on start reading!!!
For buying outside funds, are those typically still subject to the plan administration fees? As an example, my 401k has an administration fee of 0.6% and the S&P500 fund has a total cost of 0.63%, meaning the underlying fund has a cost ratio of a low 0.03%. I assume I can’t bypass that administration fee by holding other funds? Is 0.6% administration fee considered high?
Yes, ours is in the 0.2% range.
And that administration fee applies, even if I find a fund through a brokerage window?
Depends on the plan. Read the plan document. For example, in my plan, if I use the funds in the plan I pay about 0.2%. If I use the brokerage window (PCRA at Schwab) I pay $200 a year. It turns out that $200 a year is much less than 0.2%. So I use the brokerage window and buy ETFs.
60 basis points for plan administration is high. It should be no more than 15 basis points. In your example you have TOTAL costs of 63 basis points (3 basis points for the fund’s expense ratio and 60 basis points for plan administration. Your fee for plan administration is 20 times greater than your fund’s expense ratio.
That said, your example shows us that the two fees must be added together to determine the actual fees paid to invest. You are over stating your investment return if you just subtract the expense ratio.
Unless you’re calculating your returns post-fees.
Either way there is less growth.
My plan has the PCRA option with Schwab but they charge $50 a year for that. Is it worth it?
Do you get out of other fees? I do. I’ve exchanged a 0.2%-0.3% fee for a $200 fee (which is much lower.) But if your investments options in the 401(k) are crummy, then yes, I’d pay $50 to get better ones.
I never understood the purpose of brokerage accounts. If you have a plan with plenty of low cost index funds there is no need for a brokerage account in the first place. Brokerage accounts are a huge liability for the plan sponsor especially because most plan sponsors have no idea how to monitor those types of accounts to make sure they are in compliance with all applicable laws and regulations (and in some cases it is nearly impossible to monitor if there are many participants using these accounts).
However, as a participant, if that will give you a way to escape a lousy mutual funds menu in your plan, then by all means you should take it. The downside is that you now need to research all of the Schwab index funds, which are quite limited vs. Vanguard or even Fidelity for example. However, Schwab has plenty of ETFs which are low cost, so if you are using the brokerage, I would use Schwab ETFs, which you will also need to research.
Schwab PCRA allows you to buy any ETF. You do have to pay commissions, but the cost is low. I generally spend less than $50 a year in commissions and mostly use Vanguard ETFs.
In Schwab brokerage accounts I try to use Schwab ETFs because those do not have commission on them. And a number of Schwab ETFs are just as good as Vanguard ones, so I’m actually able to replace all Vanguard ETFs I use one for one with Schwab commission-free ones. However, if you just want to use Vanguard ETFs in a Schwab brokerage window, that’s perfectly fine too, as it cuts down on the amount of research that has to be done.
WCI -Whether you are allowed to buy ETFs and individual stocks or are limited to mutual fund offerings depends on the company 401(k) plan. Schwab has two separate “Welcome packages” that describe each type of PCRA plan. I was disappointed to learn my former company only offered the mutual fund option. Although there are over 1000 funds to choose from, most of them carry expense ratios in the range of 0.5% to 1.5%. The Schwab and Vanguard low cost index funds are the only funds I have any interest in, maybe 20 funds but still an improvement over the choices in the stock 401(k) plan. The materials from my 401(k) provider were a bit misleading, they clearly implied that individual stocks, ETFs and mutual funds were available options withing the PCRA. Only after I had enrolled in the PCRA plan and funded it did I find out the limitations after talking to a Schwab advisor and gaining access to materials on the Schwab website that are only provided to PCRA investors.
Minor note – My PCRA plan carries an additional fee of $12.50/quarter, or $50 annually. Charged by my 401(k) plan provider, not by Schwab.
Interesting. I must have a different one where you can buy anything. I didn’t know there were two. I think the whole account is back in SCHP now anyway as my stocks will soon all be in taxable.
With ERISA compliant SDBAs opened from within the plan you can restrict the types of investments that go into SDBAs. Typically you can restrict to just mutual funds, or mutual funds and ETFs, or all of the above plus individual stocks, and more (options can be allowed as well, though I would not go that far). This is all detailed in the agreement that is provided by the SDBA custodian. I’m more familiar with TD Ameritrade, though I would assume that all custodians have some amount of restrictions available, and it is possible to restrict SDBAs at the plan level.
Re: #7 PCRA plans. Does anyone know if funds directed to PCRA type plans have the same legal protections as the underlying 401(k) plan? Or are the transferred funds treated as a IRA rollover even though they remain under the “umbrella” of the 401(k) plan sponsor/gatekeeper?
Nah, they’re 401k money for asset protection purposes.
If your self-directed brokerage account is kept outside of the plan (such that you’ve opened it independently, not from within the plan), and if the tiling of the SDBA account is not done correctly, it can potentially lose ERISA protection.
I have 2 old 401K’s that are crummy (and the job was crummy too). My new employer 401K is pretty good with index funds that range in expense ratio from 0.04 to 0.6. I also have a solo 401K at TD Ameritrade which I haven’t funded yet with 1099 income employER contributions. TD Ameritrade has told me that even though the solo 401K is at $0, I can roll old employer 401Ks into it.
Would you recommend rolling my old employer 401Ks into the solo 401K at TD Ameritrade or into my new employer 401K?
The pros of the solo 401K at TD Ameritrade is that I can invest in anything (but which can lead to indecisiveness), but I’m also worried that down the road they might say that this was not allowed since I never used the solo 401K for its original purpose which was to put my 1099 income employER contributions in.
Thanks.
The new employer one may have slightly better asset protection in your state, but in general I prefer having money in a 401(k) that I have more control over.