Typical 401k Questions

Typical 401k Questions  <Click here to see Sara’s video introduction to this post.

This post covers some of the questions that I’ve heard from folks regarding investing in 401(k) and 403(b) plans.

Q: What can I read to learn more about how to invest my money?

A: Start here with my blog posts and then let’s pick it up from there.
www.saragrilloinvestments.com

401(k)lutz

You Can’t Live in Those Gucci Shoes

You Can’t Eat the Prada Bag

The SMOOTH Way To Talk To Your Man About His Money

Will You Marry Me – Assuming Your Credit Score is Above 700?

Money Ninja

Q: My question is: what does the employer get out of this deal? Isn’t the benefits manager who makes the decision on where to invest responsible for finding the best performing fund(s)? I’m so cynical at this point I’m wondering if the companies who place their employees’ trust and money in these funds gets a financial benefit (um, kickback).

A: Generally the company does not get a “kickback” but if it does, that would be disclosed in the Summary Plan Description (SPD). This is the guidebook to the 401k and your HR department should give that to you on an annual basis. If not, request it.

The benefit to the employer is, simply put, competitive advantage. It’s a benefit to prospective employees that differentiates the company vs. other prospective employers, just as salary, vacation, etc.

Most of the time there is no financial reward for the company for offering a 401k or 403b plan.

Q: I would like to hear what others feel is a better alternative to 401k. I will be among many in a large layoff at the company I’ve been with for 14+ years in the next couple months. There are funds I need to decide what to do with in my 401k, but where & what do I do with them?

A: An employer sponsored plan is a form of closed architecture investing. That means that your options are limited to what the company offers. In my blog 401(k)lutz, http://saragrilloinvestments.com/?p=1554, I discuss the reasons why these funds are not always the best out there.

If you choose to invest outside of your employer plan, there are several ways to do it. Brokerage accounts offered through a company such as Fidelity or Charles Schwab are open architecture solutions, but you’ve got to come up with the investments yourselves.

Investment is very personal. This link provides information about the things that should happen in order to arrive at a set of investments that are suitable for a specific person:

http://saragrilloinvestments.com/?page_id=345

Q: I would encourage you to contribute as much as possible to your plan. Many plans have financial planners available who can help you determine the funds that are best for you.

A: I’m not sure that it’s always best to contribute as much as possible to your plan. An employer sponsored plan is a form of closed architecture investing. That means that your options are limited to what the company offers. In my blog http://saragrilloinvestments.com/?p=1554 I discuss the reasons why these funds are not always the best out there.

If you can find better investments elsewhere, contributing as much as possible to your employer plan is not the best way to earn the highest return possible given the risk you are assuming, fees you are paying etc.

This decision is not simple. There are no hard and fast rules for how you invest your money. It varies from one person to the next. Investment is very personal. This link provides information about the things that should happen in order to arrive at a set of investments that are suitable for a specific person:

http://saragrilloinvestments.com/?page_id=345

Q: Why aren’t benefit administrators more knowledgeable about this. And who else benefits (aside from the fund) from our collective ignorance.

A: The onus is not on the plan sponsor to make investment decisions for participants. That is up to participants. If participants can not make these decisions for themselves, they should find a professional to help them. Most advisors have a fiduciary obligation, which means that they have to make decisions based on what is best for the client rather than what lines their pockets with the highest fees. Brokers are not necessarily fiduciaries.

Benefit administrators are responsible for providing the tools for participants to make decisions, and to then educate participants about what the tools are. But they are not responsible for providing investment advice because it is too high a liability for them to assume. They are responsible for administration, not advising, of 401k investments. That’s a very important distinction because crossing that line increases the level of liability and would require administrators to have different credentials than the ones they are required to have now.

Generally the company does not get a “kickback” but if it does, that would be disclosed in the Summary Plan Description (SPD). This is the guidebook to the 401k and your HR department should give that to you on an annual basis. If not, request it.

The benefit to the employer is, simply put, competitive advantage. It’s a benefit to prospective employees that differentiates the company vs. other prospective employers, just as salary, vacation, etc.

Most of the time there is no financial reward for the company for offering a 401k or 403b plan.
Q: I agree that it is a good idea to contribute whatever the company matches to the 401k. That’s like free money, right?

A: Well, not really. Although it seems like you are getting money for nothing, remember that if the company is dolling out money by matching employee contributions, well, that means they are increasing their costs. That’s money they aren’t giving out in bonuses or other forms of compensation such as salary. So although you aren’t paying directly for this matching, in an indirect way you are.

Be sure to read your plan documents, such as the Summary Plan Description, or SPD, to figure out exactly what you are paying by participating in your employer plan.

For example, the company is likely deducting small fees for recordkeeping, legal expenses, etc. Small charges can add up over time. That’s why if you’ve got a 403(b) or 401(k) plan at a past employer, it might make sense to consider rolling it over into a qualified account such as an IRA. You may wish to consult a tax advisor for help with this process.

Q: Just try to pick the most reputable fund from the list. How do you know who is “reputable”, btw?

A: The process of picking an investment is multidimensional. There are numerous factors that make a fund good or bad: the expense ratio, the mix of assets, the potential for good or bad performance, the quality of the investment manager, the size of the fund, and other factors. Reputation is a characteristic of a fund but sometimes it has nothing to do with the aforementioned factors which are extremely relevant.

Investment is very personal. This link provides information about the things that should happen in order to arrive at a set of investments that are suitable for a specific person:

http://saragrilloinvestments.com/?page_id=345

Q:; Overall, it sounds like it’s a good idea to diversify:
For example, you want to save 10% and your company offers a matching 4% in 401k. So, you put up the 4% into the 401k and do something else with the other 6%. Maybe just buy the index like DOW. It’s something you could probably even do yourself (through e-trade) and save some money on the fees. Or a few safer purchases like CDs through your bank.

A: Diversification can be a tricky subject.

Investing 4% in a 401k and 6% in your Roth IRA, for example, doesn’t guarantee diversification. As I discuss in my blog 401(k)lutz, http://saragrilloinvestments.com/?p=1554, a common mistake that people make is neglecting to view their plan balances in relation to other investments. For example, if you own a house, it might double up on risk to invest your whole 401(k) in certain real estate funds. At least once a year, conduct a thorough financial analysis that combines all IRA or individual brokerage accounts with your employer plans. Examine your holdings for overlap and sector/industry concentrations. You may wish to consult a financial advisor, as this process can be quite involved.

About the DOW fund mentioned, the majority of investment options in an employer plan tend to be actively managed mutual funds. Mutual funds commonly carry higher management fees than index funds because they are actively, as opposed to passively, managed. However, lower fees don’t necessarily mean an investment is right for you. There are numerous factors that have to be taken into account.

In regards to investing in CD’s, many of these instruments have suffered yield compression due to the low interest rate environment of today’s market. For this reason, you may not be making more than inflation is you invest in certain CD’s. CD’s can be great investments but you should be aware of the real, as opposed to nominal, rate that you’ll be earning after fees and taxes are taken out.

There are no hard and fast rules for the “hot” investments that are right for everybody. Investment is very personal. This link provides information about the things that should happen in order to arrive at a set of investments that are suitable for a specific person:

http://saragrilloinvestments.com/?page_id=345

Q: I’m almost 27 and will finish paying off my student loans in a couple of months. Right now I contribute 6% to my 401K. What should I bump it up to after my loans are paid off? My only other debt is my mortgage.

A: The total amount that can go into a 401k is limited to a certain amount for the year. You’d have to make a projection about what your contribution rate should be, taking into account your salary and other factors. If you are bearing debt, you may want to consider the interest rate on the debt and how that relates to the anticipated return from your 401k holdings. If you bear a large amount of debt at a high interest rate, perhaps it makes sense to knock out some of it instead of putting money away into a 401k. The answer to your question would best be arrived at through some calculation and comparison.

Q: Never pick a fund based on past performance… then how should you pick a fund is the obvious question…I’ve played around on FOREX for a while and there are various ways to pick entry and exit positions by analyzing the charts. Maybe is kind of like that?

A: The process of picking an investment is multidimensional. There are numerous factors that make a fund good or bad: the expense ratio, the mix of assets, the potential for good or bad performance, the quality of the investment manager, the size of the fund, and other factors. Reputation is a characteristic of a fund but sometimes it has nothing to do with the aforementioned factors which are extremely relevant.

Investing something as important as your life savings shouldn’t be approached as gambling. Care and prudence must be espoused. You should never invest even a dollar of money into something unless you totally understand every single part of it. Trading in the foreign exchange markets is one way to generate returns, but it is a bit risky. If you have an expert knowledge of the currency markets, then by all means, you might wish to try your hand. If not, it’s best to consider other investments that you are more knowledgeable about.

There are other ways to generate returns that might be a bit less volatile. Other asset classes such as large cap high dividend equities tend to exhibit lower volatility than commodities or currencies. However, it all depends on the specific investment.

The level of risk of your investment has to match with the amount of risk you are willing to bear. This varies from person to person and should be evaluated through a comprehensive question and answer process that gets to the heart of what your pain points are in terms of your willingness and ability to suffer downfall from market declines.

A good financial advisor assesses risk according to two factors: the person’s willingness and ability to take risk. Willingness and ability are not always the same. Someone with 30 years to retirement has a high ability to bear risk, but that doesn’t mean he necessarily wants to see large fluctuations in his account value? Not necessarily. He may be more conservatively minded than other people his age. What if he has dependent relatives, a mortgage, or is depending on his 401(k) for medical expenses? In other words, these funds are impersonal and they may fail to capture your individual risk tolerance properly.

Investment is very personal. This link provides information about the things that should happen in order to arrive at a set of investments that are suitable for a specific person:

http://saragrilloinvestments.com/?page_id=345

Disclaimers

This is neither an offer to sell nor the solicitation of an offer to purchase any interest in GIM or any other investments discussed. This publication is for informational purposes only; it is not intended to be a solicitation, offering, or recommendation by Grillo Investment Management, LLC of any product, security, transaction, or service. It should not in any way be interpreted as investment, financial, tax, or legal advice.

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This presentation and its contents are proprietary information of GIM and may not be reproduced or otherwise disseminated in whole or in part without GIM’s consent. All data herein was obtained from publicly available information and/or sources, internally developed data, and other sources believed to be reliable. Except as otherwise stated, GIM has not sought to independently verify information obtained from public or third party sources and makes no representations or warranties of any kind, express or implied, regarding the accuracy, completeness, or reliability of such information.

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