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I don't expect a huge number of funds to choose from in a 401k plan, but all the plans I've ever seen are loaded with funds that have outrageously high management expense ratios (MERs) and they underperform. (This is not just for one company – it's been true at every place I've worked, I've seen people complain about 401k lousy choices on this site, and have heard people complain about this phenomenon in other contexts.)

Often the best you can hope for is an S&P 500 index fund with a low MER, and sometimes even that isn't available.

You could easily replace the actively managed bond fund with a low-cost index fund, same for the small caps.

What is it that creates this situation?

Does anyone have a success story related to getting 401k options changed for the better?

(I'm wondering if it's worth lobbying for change, or if I should just put everything into the S&P500 fund and allocate into other asset classes outside this account.)

  • It sure doesn't hurt to ask. Write up a short memo with the boss view showing how they can save money and I bet you can get something happening. – MrChrister Apr 2 '11 at 17:05
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    Our 401k provider made an interesting point at our last enrollment meeting. Apparently history has shown that participation rates in 401k plans drop significantly when too many funds are available. When presented with too many choices people get decision anxiety and perpetually put off filling out the paperwork. – JohnFx Apr 3 '11 at 18:44
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    @JohnFx: I've heard stats like that before. I'm not looking for more choices. They could offer three or four index funds with low MERs and I'd be satisfied. – bstpierre Apr 4 '11 at 1:12
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    @bstpierre I've seen success if you persistently ask for a specific type of fund. For example, send specific feedback on what you want (Russel 2000 index fund, etc.) and send it once a quarter or similar. Giving specific requests gets better responses than vague, "make it better" requests. Then, ask your coworkers to send or forward the same email to HR. – Alex B Apr 4 '11 at 17:07
  • My 401(k) offers an S&P500 index fund with an expense ratio of 1%. You couldn't imagine a more plain-vanilla low-cost zero-effort sort of mutual fund, and they see fit to take out 1% of your money each year? Seriously? – fennec Apr 5 '11 at 0:43
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401k choices are awful because:

  • The 401k lobby is powerful.
  • The customer is a captive audience.
  • Most participants do not know they are awful, thanks to expense ratios.

The best remedy I have found is to roll over to an IRA when changing jobs.

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    In addition, the 401k industry has cleverly left the employer liable. Employees who are aware of the problem are left in the awkward postion of having to confront the hand that feeds them. – James Roth Apr 4 '11 at 20:14
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I would point this out to the committee or other entity in charge of handling this at work. They do have a fiduciary responsibility for the participant's money and should take anything reasonable seriously.

The flip side to this is 95% of participants -- especially participants under 35 or so -- really pay next to no attention to this stuff. We consider it a victory to get people to pony up the matching contributions. Active participation in investment would blow our minds.

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The managers of the 401(k) have to make their money somewhere. Either they'll make it from the employer, or from the employees via the expense ratio. If it's the employer setting up the plan, I can bet whose interest he'll be looking after.

Regarding your last comment, I'd recommend looking outside your 401(k) for investing. If you get free money from your employer for contributing to your 401(k), that's a plus, but I wouldn't -- actually, I don't -- contribute anything beyond the match. I pay my taxes and I'm done with it.

  • Yes, I have to capture the match. Re my last comment, what I meant was that I have to put the money into something, and the index fund is the best bet. So as the amount of "US Large Cap" increases in the 401k, I'll have to reduce holdings of this class outside the 401k to maintain my targets. – bstpierre Apr 2 '11 at 3:57
  • The 401k managers do have to make money. I'm willing to pay for value. What I object to is paying extra fees for fund management that doesn't add value. They could offer index funds, drop MERs from 1.75% to 0.5%, which is still a significant markup, and still make decent money. – bstpierre Apr 2 '11 at 4:04
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    The point is you're not in charge of picking who manages your 401(k). Your employer is. He's likely to look at his bottom line, not how much the expenses on the funds are. You pay those, not him. If he can get a 401(k) program in place for less, would you fault him if you were in his shoes? – mbhunter Apr 2 '11 at 4:10
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To piggy back mbhunter's answer, the broker is going to find a way to make the amount of money they want, and either the employee or the company will foot that bill.

But additionally, most small businesses want to compete and the market and offer benefits in the US. So they shop around, and maybe the boss doesn't have the best knowledge about effective investing, so they end up taking the offering from the broker who sells it the best.

Give you company credit for offering something, but know they are as affected by a good salesperson as anybody else. Being a good sales person doesn't mean you are selling a good product.

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