Why don’t more 401(k) plans include index funds?
This weekend, the Boston Globe had an article on a change made to 401(k) investment plans during the Bush administration. The change enabled businesses to automatically enroll employees in the retirement plan ‘” employees would have to take action to opt-out. In addition, if the individual didn’t specify how to invest the funds, they would automatically be invested in stock-heavy funds. The Globe article estimates that 1-2 million workers were affected by the new law, and of course with the markets in a free fall, these employees have lost much of their initial investment.
This origin of this change was the Pension Protection Act of 2006. The Act changed many things about pensions and retirement accounts, including creating the default opt-in for 401(k)’s. It would seem to be a good idea ‘” to give a bit of a push to those folks who are reluctant to fund their retirement accounts, presumably out of procrastination or trepidation. The default investment was determined by ‘œSection 624(a) of the Pension Protection Act directed that such regulations provide guidance on the appropriateness of designating default investments that include a mix of asset classes consistent with capital preservation or long-term capital appreciation’¦‘ In other words, the default was a conservative investment. Fast forward to December 10, 2008 and the swift pen of the Joint Committee on Taxation, p. 12, relieved the restriction on default investments. Hmmm’¦ that was about 41 days before Obama took the reigns. D’ya think maybe there was just a wee bit of lobbying going on by the investment powerhouses?
I searched, but did not find the reference to requiring companies to make investments on behalf of employees in stocks instead of more conservative alternatives. I would be interested to find the source for the Boston Globe’s article. But it’s easy to see that if an investment company is allowed to direct the investments, they are probably going to choose a stock fund, with its higher expenses, over a simple money market fund, CD, or bond fund.
Which made me think, hey’¦ with all this talk about investment choices, why don’t more 401(k) plans offer index funds? They have much lower expense ratios and generally better track records than managed funds, if you consider the return after expenses. My employer’s 401(k) plan offers two index funds as a part of 27 investment options. While asset class is certainly important, doesn’t expense ratio deserve equal footing? And while big brother was demonstrating his concern for us, why not make the expense ratio one of the criteria for choosing the default investment.
Let me know. Does your employer include index funds in your 401(k) plan?
No index funds in my 401k plan. I remember when they did this. You have to wonder what went on in Bush’s mind. Another way to pump money back into the economy ,I suppose.
Helen: As much as I disliked the Bush administration, I think the “opt-in” option as the default is the right approach. I agree though that being automatically invested in stock-heavy funds is a break in the system (and as you suspect, result of lobbyists).
This got me thinking about the 401(k) plan that I participate in (yes, the current one offers some Index funds) and I noticed that fine print where “An Important Message about Investing for Retirement & Diversification” points participants to this page on the Dept of Labor’s website that includes the publication: Savings Fitness: A Guide to Your Money and Your Financial Future and the recommendation to rebalance every quarter:
Hmmm… the problem here is that they assume employees will look at their statements and take an active approach in managing the investments in their plan. I have an extracurricular interest in money and barely glance at these quarterly statements. I can’t imagine the average person is going to “rebalance” anything. Therein lies the problem…
Interesting topic. Thanks for raising the issue and pointing out the Globe article.
Helen, if you can’t find a source for an article in the Boston Globe, it’s probably because they fudged it.
I think Nina makes an excellent point about rebalancing and people not taking an active part in their investments. Until I started reading and writing for Queercents, I never would have known the difference between a 401k, traditional IRA, Roth IRA, or any other type of retirement plan. Most people are in the same boat, and I think they assume that their money will be there when they retire and they don’t have to do anything about it because the money is automatically deducted from their checks.
I did a short stint with a 401k administrator and the inaction on the part of participants is precisely why the opt-in feature was added. The vast majority of people with access to a 401k STILL did not contribute EVEN when there is a match. My understanding is that employers have a limited choice as to the default fund, a money market or a target date retirement fund. The target date funds are good in theory as they are age appropriate and offer the participant a much better shot at growth beyond inflation than a money market fund. And yes of course this also benefits the financial services industry as these are more expensive than mm funds. Many feel the problem lies in the overly aggressive allocation in the target date funds, especially for those close to retirement age.
I believe it is blogs like this and other good money blogs out there that people are turning to for education. It is a relatively recent phenomenon that individuals are responsible for their own retirement and I sense there is this feeling of “I must be supposed to know this” coupled with a complete lack of formal education in matters of personal finance.
Carol: Can you please enlighten us on the process that a 401k administrator used to choose the investment options for a company plan?
Every 401k I’ve participated in has had some real dreck (high expenses, poor performance, low Morningstar rating…), and I’ve always wondered how they got chosen. My current employer’s plan has some good options — enough to make a reasonably diversified portfolio, but there are also some really bad options.
I hate to think that the HR guy is getting a kickback — that just seems too cheesy. More likely, I suspect that the investment company — Fidelity, Schwab… — is offering a basket of selections and that the employer’s representative has little choice about it.
But that’s just my guess about the investment selection process. If you (or anyone else) can enlighten us, I’d appreciate it.