401K: Focus on Fees

Subtransfer agent fees, early redemption fees, custodial fees, wrap fees, investment adviser fees, 12b-1 fees, brokerage commissions, administrative fees, revenue sharing fees and fees for services… The list is so convoluted and endless, the mutual fund firms can’t even create diagrams depicting the fees that can be readily understood. If the industry itself can not even determine how they are fleecing the plan participants then how are the corporate sponsors and employees ever expected to figure it out.

Fortunately the Department of Labor is stepping up to the table with demands that the fees are properly disclosed on the ERISA-required form that every plan must file annually with the federal government. The changes are expected to be put in place in January 2009.

Hopefully these changes will help end the 401K plan practice of finding every possible angle to stick it to investors. A recent HingeFire post (see What is the cost to beat the market?) outlined how mutual funds have found new inventive ways to pick the pockets of mutual fund investors. Fees can make a significant difference in the amount of funds available for an employees’ retirement and it is critical that 401K plans are more transparent with all the expenses charged to plan participants.

Bankrate asks “Why's Your 401(k) Plan Heading South?” -- the answer is Fees.

Lifecycle that makes sense

Many savvy financial experts are hesitant to recommend lifecycle or target-date funds because many are just a pyramid of fees; burdening the investor with the expenses of both the underlying funds and additional fees for the management of the life-cycle fund. These funds come across to many as just another way for fund families to increase their revenue. Coupled with the reality that very few of these funds outperform their associated indexes, most investors would be better off managing their own diversification.

The crux of the problem is the expenses; automatic lifecycle as a concept works if the fees can be reduced. Fortunately there are a number of ETFs now offered that provide expenses that are typical less then half of most life cycle funds in the market. Target date funds are popular conceptual with investors simply because you can “set & forget”; the advent of life-cycle ETFs are likely to enhance their broad acceptance with the probable added benefit of driving many large mutual fund families to reduce their fees for these vehicles.

TD Ameritrade and XShares have launched five new target-date ETFs; TDAX Independence 2010 ETF (TDD), TDAX Independence 2020 ETF (TDH), TDAX Independence 2030 ETF (TDN) and TDAX Independence 2040 ETF (TDV) and TDAX In-Target ETF (TDX). These target-date ETFs have expense ratios of 0.65%, compared with about 1.3% for the average comparable mutual fund, Other ETF underwriters plan to offer other lifecycle choices shortly, many of these will have even lower expense ratios.

The recent round of pension reform, in which QDIAs were defined by the U.S. Department of Labor, will place lifecycle offerings as the default investments in numerous 401K plans. Many of these retirement plans will likely start considering the ETF lifecycle products as employees clamor for lower fees.

New ETFs Target Retirement Market
http://finance.yahoo.com/focus-retirement/article/103739/New-ETFs-Target-Retirement-Market?mod=retirement-401k

What is a QDIA? and why should I care?

QDIA stands for ‘qualified default investment alternative”. The recent determination of what investments qualify as QDIAs opens the door for automatic enrollment of many Americans into their corporate 401K plans. Nearly 20% of workers do not enroll in their corporate plans, many times missing out on company matching and the ability to accumulate funds for retirement.

Under the Pension Protection Act of 2006, employers can now automatically enroll their employees in the company’s 401(k) plan. However firms have been waiting on the ruling by the U.S. Department of Labor regarding what meets the requirement to be QDIAs before moving forward.

Employers can now direct the funds of automatically enrolled employees to balanced mutual funds, lifecycle / target-date funds, and managed accounts. Stable value funds and guaranteed insurance contracts (GICs) no longer meet the criteria to serve as QDIAs in 401K plans. Most financial planners view this change in a positive light; balanced and lifecycle funds are far more appropriate for 401K retirement plans then fixed rate investments focused on capital preservation.

Qualified Approval
http://finance.yahoo.com/focus-retirement/article/103820/Qualified-Approval?mod=retirement-401k

For Golden Years: Stick with Proper Portfolio Diversification

In the current environment where the gains in foreign markets have outsized the U.S. indexes over the past few years, there are an increasing number of articles focusing on the benefits of investing overseas. Urged on by many international funds, the financial media has been hyping American investors to greatly increase their exposure to foreign markets, sometimes to the point of recklessness.

It is important that investors adhere to standard diversification strategies to ensure long term success. Greatly increasing your exposure to foreign markets now simply because they have had a good run is not prudent; remember past performance in no guarantee of future performance. Investors should keep in mind that international markets, especially emerging markets, are extremely volatile. They are just as likely to go down 50% per year as up 50% per year. The trend of the falling dollar which has ignited international gains can reverse at any given moment, backing up like a bowling ball to mow down your overseas investment returns.

Keep in mind that your retirement is funded in U.S, dollars; this usually implies that your exposure to dollars should significantly exceed the percentage capitalization that the domestic markets represent. Merely matching your domestic portfolio allocation to the 50% capitalization represented by U.S. equity markets is not sufficient. Especially in view that many of the foreign markets representing the bulk of the world capitalization lack the regulative oversight and adequate disclosure of the American stock markets.

Increasing your exposure to international investments now is really a form of market timing, something most financial advisors urge you to avoid. It makes more sense to stick to a long-term properly diversified portfolio that aligns with your age and risk tolerance.

One example of an article pushing investors to greatly increase their foreign exposure is this recent gem from Forbes:

For Golden Years, Invest Abroad
http://finance.yahoo.com/focus-retirement/article/103799/For-Golden-Years,-Invest-Abroad?mod=retirement-IRA