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Rating Your 401(k)

Christine Benz

Morningstar's 401(k) Week kicks off Monday, and we'll be looking at America's core retirement vehicle from a number of angles: the basic rules and tax advantages of the investment wrapper, how to allocate your 401(k), and what to do with your 401(k) assets once you enter retirement. We'll also be looking at the viability of the 401(k) itself in a special roundtable discussion Friday.

To tee up the topic, I asked Morningstar.com readers to evaluate the quality of their own plans. In what ways do their plans excel, if any, and where could they improve?

Low-fee funds and generous employer matching contributions were among the 401(k) features that respondents said they value the most. But--and this helps showcase the broad variations in quality among plans--other posters griped about high-cost fund lineups, miserly matching contributions, and the lack of a brokerage window to serve as an escape hatch from subpar investment lineups.

Many posters were nuanced in their assessments of their plans. Several said that even though their plans' investment lineups have holes, low costs helped make up for the limited choices.

'Low Costs and Simplicity Make It Hard to Go Too Far Afield'
Several posters said that they appreciated their plans' ultra-low-cost investment options.

Among the features Darwinian values in his 401(k) plan? "[Its r]eally, really low-fee index funds. S&P 500: 0.01% (yes, 1 basis point). TIPS fund: 0.03% and outperforms Vanguard's. Small-cap index: 0.04%."

In a similar camp is Phil56, who's able to take advantage of the federal government's ultra-cheap plan: "I am part of the Thrift Savings Plan, established for military and federal government employees. The fees are very low across the fund offerings, and the choices include conservatively allocated target date funds, basic indexes (S&P 500, small and medium cap, EAFE international, a bond index fund), and a cash fund that pays just under 2% at present."

Phil wouldn't mind having more options, but notes that the skinnied-down menu helps keep people from dabbling in investment options they don't understand: "Some options have to be found elsewhere; for example, there are no sector funds or a REIT [fund] but that strikes me as okay given the learning curve required to make sensible investments in those areas."

Mrpcid is on the same page: "[My plan] offers very few choices--company stock, S&P 500 index, extended market index, international index, bond index, stable value. On the bright side, these are super-low cost, with numbers similar to those Darwinian mentioned. I miss having a brokerage option, but the silver lining is that the low costs and simplicity make it hard to go too far afield for one's own good."

Other posters said that they like to venture beyond their plans' preset lineups and invest via the plan's brokerage window. Wrote Dragonpat, "The best feature of my company 401(k) plan is the brokerage window at Schwab.... Previous to this the only bond options in our 401(k) was the bond portion of Vanguard Wellington (VWENX), the stable-value fund, and a long-term Treasury fund. Now you can invest in any mutual fund and expand your bond-fund holdings."

Posters also said that they appreciated the opportunity to obtain guidance through their plan. GuppaZ155, who uses the plan's brokerage window, wrote, "The best part is that people choosing the [brokerage window] option are allowed access to a certified financial planner at Merrill, which is invaluable for year-end rebalancing or bouncing off ideas on future direction, fund choices, buying ETFs, etc."

For Dawgie, a big benefit to the plan is the ability to customize a portfolio's positioning to suit the investor's own specifications: "Portfolio[s] can be rebalanced as often or infrequently as desired to set allocations with a simple click of the mouse. This is perhaps the biggest advantage to our 401(k), and allows me to boost returns when markets fluctuate a lot. Asset allocations can also be changed at will. Investors can set their own asset allocations or choose from a range of portfolios depending on age and risk tolerance."

'My Employer Is Generous to Us'
For other respondents, employer matching contributions are the key benefit of their plans.

BMWLover wrote, "My 457 gets it right because my employer is generous to us. I receive a flat 4% of my salary contributed to our plan plus the first $2,000 that I contribute is matched dollar for dollar, and there is no vesting period for any of my employer's contributions."

Also appreciative of generous matching contributions is Juris2: "The very best thing about my 403(b) is the 10% employer match to my 5% contribution, both with immediate vesting."

Dragonpat enthused about a new feature that enables participants to take full advantage of matching. (Employees can miss out on part of the match if they don't space their contributions throughout the year.) "Another feature that [my employer plan has] recently implemented is 'topping up.' ... Now you can get [the full] match when you finish contributing to your 401(k) earlier than December."

'My Big Complaint Is the Fees'
But respondents weren't universally enthused about their plans. Numerous respondents griped about high-cost plans larded with subpar investment options.

Gatorbyter's plan falls down on several levels: "My Fortune 250 employer's 401(k) is fairly vanilla, but I have three major gripes: 1) the fund options are very limited in number (literally eight excluding the [target date] funds), 2) the expense ratios are about twice the mutual fund 'average,' and 3) the funds are specific to the employer, that is, there is no fund symbol and minimal detail available on what is in each 'black box.'" (Note that non-name-brand investment options aren't inherently weak, but it sounds like Gator's options are truly subpar.)

SilSanders also has trouble conducting due diligence on the non-mutual fund options in the plan, noting that, "The amount of information available about them is limited so one is forced to assume they are almost equivalent to the institutional share class of the corresponding fund."

Worthy of complaint for TommyLee is a total fee level of 1.5% per year, and this investor's requests to cheapen up the investment lineup have fallen on deaf ears. "No index fund options," TommyLee wrote. "I asked about getting them added. When directed to our broker I was told that she had already picked the best funds available. Adding index funds would be 'too confusing.'"

As BMWLover's post illustrates, participants in smaller plans sometimes get stuck with high-cost investment choices because their plans don't enjoy the same economies of scale that large plans do: "As always, my big complaint is the fees. Because we are a small employer our fees are high. On top of the fees built into NAVs of the mutual funds, we also pay 0.60% in administration fees as well. Yes, I hear that sucking sound, but finding an administrator that charges less has been next to impossible."

Yogibearbull agreed that small plans can be the worst offenders: "[Morningstar] should focus on the problems with smaller 401(k)s/403(b)s where the options are fewer and expense ratios are high. There are often crony plans where the boss [or HR boss] deals with a close friend or relative to run bad 401(k)/403(b) plans."

Evolence's plan has its pluses, but its costs are egregious by any measure: "[The] cheapest fund is a bond fund that rings in at a 1.10% expense ratio; the most expensive is a small growth at 1.92%; the default target date options are around 1.47%. A couple of the Oppenheimer funds have deferred sales loads of 1%. That cost isn't helped by the inclusion of 0.25% 12b-1 fees."

In addition to high baseline costs, Evolence's plan also nickels and dimes participants with extra fees: "There is a $50 termination fee, as well as a comparable fee for any time you need to take a distribution."

'I Can't Get the Allocation I Want'
Even posters who are content with their plans' fee levels would like to see some more choices. Darwinian's plan, for example, includes "[N]o value funds. No stable value fund. No brokerage option."

Dawgie, while also generally satisfied with the quality of the plan, regrets that there are "no funds available in many more specialized categories such as real estate, multi-sector income, emerging markets, high-yield bonds, and balanced/asset allocation."

Mdcollins, an index enthusiast, happily invests in passive products for U.S. exposure, but would like to be able to use index products for other asset classes. "There is no international index fund, or a U.S. bond market index fund, or an international bond market index fund," this poster wrote.

Dndhatcher, while satisfied with several funds in the plan, wrote, "The problem for a more experienced investor is that there is only one fund in foreign stocks and one in bonds. There is no emerging-markets, stock or bond, fund. I can't get the allocation I want in either bonds or foreign markets."

Several posters said that their plans fall short in terms of providing information. Wrote Dragonpat: "What my 401(k) could do better is on data on the regular 401(k) holdings. You have to know exactly where to look to find the expenses, and you cannot compare all the holdings at once on a single screen. You also cannot see the growth of $10,000 over time for more than one fund at a time, and because some of them do not have tickers on the exchanges, you can't just put the tickers in a M* chart and compare them either."

Nittwit, while content with some aspects of the plan, would like to see improved educational efforts, citing a poor explanation of the plan to employees and lack of assistance regarding the "amount of bonds to own versus stock for your age, active management versus indexing, and [the] rebalancing option."

Lynnee noted that even well-intentioned educational content can have unintended consequences: "Our site suddenly added a clearer description of expense ratios so employees realized how much they were paying for non-index funds. A colleague responded by selling all her actively-managed funds and buying only index funds. The problem: both our bond fund options are actively managed. Looking only at how she'd reduced her costs, she didn't realize she'd gone from a 60/40 portfolio to 100% stocks. As a conservative investor nearing retirement, she was horrified when I pointed that out."