For most individual company 401(k) retirement plan participants, the mutual fund options found on the default menu are overwhelming. It is no wonder that “buy-and-hope” is the most popular investment management strategy.
At a basic level, there are only two kinds of mutual funds found on every company 401(k) retirement plan default menu. Those two kinds of mutual funds are passive and active mutual funds.
A passive mutual fund tries to match the investment return of a major stock market index. Most likely, you have access to an S&P 500 index mutual fund on your existing company 401(k) retirement plan menu.
Index or passive mutual funds have an average expense ratio of 0.17 percent, according to Morningstar.
An actively managed mutual funds tries to beat the popular stock market averages by picking their best individual stocks. These mutual funds have an average expense ratio of about 0.75 percent.
The hope is that an active mutual fund manager picks stocks that go up in value more, and down in value less, than the U.S. stock markets in general. The research papers published in the last few years that conclude that the vast majority of active mutual fund managers fail to produce annual investment returns that beat passive index mutual funds.
The most recent study on this subject that I read concluded that less than 10% of actively managed mutual funds outperformed the S&P 500 index as recently as 2016.
By the time you add up the increased trading costs and volatile stock market returns, most individual company 401(k) retirement plan participants would be much better served owning the lower cost index mutual funds.
Then why then are over 70% of the company 401(k) retirement plan assets invested in actively managed mutual funds?
The answer can be found in the heavy promotions of mutual fund companies. The mutual fund companies can afford those advertisements because the annual expenses of their actively managed mutual funds are paid for by the individual company 401(k) retirement plan participants who own their mutual funds.
Your company pays a company 401(k) retirement plan administrator and a company 401(k) retirement plan provider to choose your company 401(k) retirement plan mutual fund menu options. Most times, these parties limit the mutual fund options to those mutual funds that are most profitable to them in the long run.
If your company 401(k) provider is Fidelity, have you ever wondered why most of the mutual funds offered are Fidelity funds? The same goes with Schwab, Vanguard, etc. Individual company 401(k) participants pay the largest part of the annual costs associated with their company 401(k) retirement plan account.
An independent, third-party investment advisor can sort out your default company 401(k) retirement plan menu of mutual fund options. It is not that hard. You just have to know where to look, and what to look for.
I rank by individual company 401(k) retirement plan investment advice client’s mutual funds by annual expense and investment performance. Those are the two main elements of long-term investment management success.
Ric Lager
Lager & Company, Inc.
