(Bloomberg View) — Over the years, I have been critical of the way 401(k)s are created, administered and managed. They can be expensive and filled with underperforming actively managed funds, some of which charge way too much. Some retirement plans offer too little diversification, especially in international and emerging-market sectors. I have also noted that the individual investor is a very large part of the problem.
I was reminded of this courtesy of a recent discussion at Morningstar FundInvestor, the investment research and mutual- fund rating company. Russell Kinnel, an senior analyst at the firm, looked at the funds that Morningstar has in its own 401(k). After all, if Morningstar can’t put together a good 401(k), then what chance does your company’s benefits administrator have? Here is the list of funds:
The good news is that Morningstar has a solid line up of options in its selection of 23 funds. Many of these have outperformed their benchmarks over five and 10 years.
The bad news is that the list is long and it can be confusing; a few of the funds are on the pricey side. The worst omission is the limited number of index funds.
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What is my beef with active funds? Companies that offer 401(k)s as part of their compensation package to employees have a fiduciary obligation to manage these properly on behalf of their workers. Experience teaches us that investors — and especially retail investors — tend to chase hot funds. A manager shows up on a magazine cover or on television AFTER a period of outperformance. He talks a great game and looks and sounds smart. The problem is this invariably occurs just before mean reversion rears its ugly head. All that earlier overperformance is offset by subsequent underperformance.
The kind of behavioral issues I write about so often are an embedded feature in most 401(k) plans. Companies that fill their retirement-saving plans with active fund managers, whose returns wax and wane with the market, encourage the kind of bad investor choices that lead to underperformance.
And not only do too many plans offer a lot of expensive funds, we also know that many people will pile into — and out of — them at the worst possible moments.