Which of these horrible funds should my girlfriend choose for her 401k?

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jasonwc
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Which of these horrible funds should my girlfriend choose for her 401k?

Post by jasonwc » Fri Jan 08, 2016 12:56 am

My girlfriend works for a small employer (less than 15 employees, only 3 of whom are enrolled in the 401k). The 401k only offers actively managed funds from American Funds. The A shares have expense ratios of 0.7-1% but contain up to a 5% load. Instead, the employer has chosen a share class (R-2) which adds a 0.75% commission to the ER. As a result, the LOWEST net expense ratio is 1.39%. The only exception is the money market fund, which has a 0.08% ER and has returned exactly 0.00% over the last 5 years. There do not appear to be any pseudo-index funds here. The ones I checked deviate substantially from the overall market. For example, the first domestic fund, AMCAP, compares itself to the S&P 500. However, it maintains an 11% cash holding and overweights growth tech and pharma stocks.

For lack of a better option, we were going to go with the 2050 Target Date Fund (ER 1.54%) but upon further inspection, it appears to be a hodgepodge of *16* different domestic and international equity funds, balanced funds, and bond funds. While the equity funds have done reasonably well (some even beat their index despite the 1.5% ER), the bond funds have done uniformly horribly, as would be expected with a 1.4%-1.8% ER in a low interest environment. This makes me think I should she should stick to equity funds in the 401k as she can can purchase BND for 0.07% in the IRA. Given that she's currently 25, Vanguard recommends a 90/10 stock to bond allocation.

Still, I'm not sure which equity fund to select.

Available Funds

Growth
AMCAP Fund (RAFBX) (1.47)
American Funds Growth Portfolio (RGWBX) (1.59)
EuroPacific Growth Fund (RERBX) (1.58)
New Perspective Fund (RNPBX) (1.55)
New World Fund (RNWBX) (1.81)
SMALLCAP World Fund (RSLBX) (1.82)

Growth and Income
American Funds Growth and Income Portfolio (RGNBX) (1.52)
Capital World Growth and Income Fund (RWIBX) (1.54)
Fundamental Investors (RFNBX) (1.42)
Washington Mutual Investors Fund (RWMBX) (1.39)

Equity Income
American Funds Income Portfolio (RINBX) (1.46)
Capital Income Builder (RIRBX) (1.39)

Balanced
American Funds Balanced Portfolio (RBABX) (1.55)

Bond
American Funds US Government Securities (RGVBX) (1.42%)
Short-Term Bond Fund of America (RAMBX) (1.51)

Cash-Equivalent
American Funds Money Market Fund (RABXX) (0.08)

[Thanks DaSeigno - I copied your list as my gf has nearly identical options.]

Her Current Status:
Emergency funds: Six months + funds for future car/home purchase
Debt: None
Tax Filing Status: Single
Tax Rate: 25% Federal (15% after $10k 401k contribution), 5.75% State
State of Residence: Virginia
Age: 25
Desired Asset allocation: 80/20 or 90/10
Desired International allocation: 25-30% of stocks
No current retirement portfolio. Recently obtained H1-B visa and became eligible for the 401k last month.

Contribution Plans:
$10,000 to 401k (This will place her into the 15% federal bracket) + 4% match
$5,500 in Vanguard Roth IRA (Since she only wants to use new funds, we'll probably use the Vanguard Target 2050 Retirement fund for its $1,000 minimum)
I have also recommended she make a $5,500 Roth IRA contribution for 2015 from her EF just to reserve the space. She can then rebuild the EF, but can always access the Roth funds should the need arise.

1) She gets a 4% "safe harbor" match. As she just opened the 401k (she just became eligible), the match should be something like 14x the ER cost in the first year.

2) She will likely leave this position within a few years, at which time she will promptly rollover the funds into a Vanguard IRA. Thus, expected ER costs should be low.
Last edited by jasonwc on Fri Jan 08, 2016 3:00 pm, edited 1 time in total.

neuro84
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Re: Which of these horrible funds should my girlfriend choose for her 401k?

Post by neuro84 » Fri Jan 08, 2016 9:57 am

I'm not experienced enough to know the answer, but those do seem like really terrible options. I don't know how they get away with a 0.7% ER on the "cash equivalent" money market fund. What on earth are the fund managers even doing to deserve that 0.7%!?

Can she talk to her employer about how awful these options are? Or is this a situation where the employer's brother is the IRA manager?

staybalanced
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Re: Which of these horrible funds should my girlfriend choose for her 401k?

Post by staybalanced » Fri Jan 08, 2016 10:40 am

It is what it is. I wouldn't spend too much time stressing over the expense ratios in a 401k plan. The tax benefit along with hopefully employer match still make it a good way to invest. Once she leaves she can rollover to low cost ira. I would only contribute up to company match and put the rest in a roth ira if possible.

1.5% expense ratio stinks, but I have seen worse. At one time I was in an oppenheimer plan that averaged over 2%. I still accumulated a lot of money in the account and rolled it over after I was no longer there. It is very difficult to lobby your HR to change, most employees are so out of touch with this stuff that you could never get the support from your peers. Most of the plan sponsors convince the decision makers that they research and choose the best funds, and that owning index funds would just be average. I know, I know, but unless you buy them a copy of random walk or something I have found most people just don't get it. Just be glad she is using pretax money and hopefully getting the match, if no match then I would just do an IRA or roth with vanguard and put the rest in taxable account. Total market funds in taxable accounts are very tax efficient.

azanon
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Re: Which of these horrible funds should my girlfriend choose for her 401k?

Post by azanon » Fri Jan 08, 2016 12:03 pm

In that scenario, I would likely just contribute enough to the employer plan to get the match, and also max the Roth. The rest, I'd invest in a taxable investment account and buy low-cost index funds.

Why? Well you mentioned she did have an emergency fund, including for car and a house. If i am safe in assuming this amount isn't so much to buy the car and house outright, then there's a great reason to keep building this up. The only potential caveat that I must admit, is that I think some (if not all) IRAs do have provisions for qualified distributions without penalty for first-time home buyers.

retiredjg
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Re: Which of these horrible funds should my girlfriend choose for her 401k?

Post by retiredjg » Fri Jan 08, 2016 12:12 pm

I'd probably use the Washington Mutual Investors Fund at 1.39% and consider it all US stocks even though it has a bit of foreign stocks. It seems to be somewhat vanilla - large blend - and does not have bonds like some of the other funds.

Even a bad 401k is worth using if a person is going to move on to other employment. Especially if there is a match that will move than cover the higher costs.

jf89
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Re: Which of these horrible funds should my girlfriend choose for her 401k?

Post by jf89 » Fri Jan 08, 2016 12:17 pm

I don't have the time at the moment to look into the individual funds (nor would I be the best to do so), but I'll point out that even a below average 401k is better than a taxable account. I don't think the ERs on these funds are SO bad that she should forgo the advantages of a 401k altogether (I know there was at least one post on here about where that threshold truly is). Especially if she only plans on being in this position for a few years, use it as a place to stash her money and ignore the results.

In the meantime, stick with the plan to max the IRA first then put remaining retirement money in the 401k. Perhaps she could broach the subject with her employer?

Edit: Found the link I was thinking of on the wiki: https://www.bogleheads.org/wiki/401(k)# ... re_choices
"Save as much as you can, diversify diversify diversify, and you can't go wrong with tech stocks" | -First investing advice I recall from my parents in the 90's (two outta three ain't bad)

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jasonwc
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Re: Which of these horrible funds should my girlfriend choose for her 401k?

Post by jasonwc » Fri Jan 08, 2016 12:25 pm

Thanks for the response guys. I actually researched other 401k options as she works directly under the company's owner. The deal is that he is only paying $500 for recordkeeping. Vanguard offered their Target Retirement funds with an ER of 0.10% as well as institutional shares for their other index funds, but there's a $3,475 minimum fee applicable whether you have 1 participant or 15. You then pay a per-participant fee for each person over 15, and the rates decline as you have more employees. I also checked on prices from Employee Fiduciary which uses Vanguard funds and targets small businesses. It charges $1,500 annually + $1,000 for the rollover from the current 401k. All the other providers I checked, including Sharebuilder, charged at least $1,500. There aren't too many small business options with low fees.

Essentially, it appears that her employer has paid an additional 0.75% in ER for the privilege of having no-load funds with a very low recordkeeping fee. None of the 401k providers I contacted could match the $500 he's currently paying, and this is probably why. At least he's offering a safe harbor match to compensate. In addition, there is a profit sharing plan in addition to the match of unknown value.

I don't think it makes sense to invest in taxable because she would then be paying 20.75% in dividend taxes (15% federal + 5.75% state). She might be better off investing enough in the 401k to drop her into the 15% bracket (0% capital gains), and then moving to taxable, though.

Based on the link jf89 provided, it appears the 401k is the best option since she will likely leave this employer within a few years:

"A reasonable rule-of-thumb is to consider investing in a taxable account if the product of the extra costs and the number of years you will stay in the plan exceeds one and a half times your combined federal and state tax rates on qualified dividends over your working career. That is, if you pay 1.70% expenses rather than 0.20%, and you pay 15% federal tax on qualified dividends, plus 5% state tax, you should still invest in the plan unless you are reasonably certain that you will stay with the employer for more than 20 years for a net loss of 30% (actually 26% because of compounding). If you pay no state tax, you should still invest in the plan unless you are reasonably certain you will stay more than 15 years."

jpelder
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Re: Which of these horrible funds should my girlfriend choose for her 401k?

Post by jpelder » Fri Jan 08, 2016 12:28 pm

retiredjg wrote:I'd probably use the Washington Mutual Investors Fund at 1.39% and consider it all US stocks even though it has a bit of foreign stocks. It seems to be somewhat vanilla - large blend - and does not have bonds like some of the other funds.

Even a bad 401k is worth using if a person is going to move on to other employment. Especially if there is a match that will move than cover the higher costs.
:thumbsup to this. It looks like a large-blend fund that tracks the S&P 500 pretty well. But just do enough to meet her savings goals after maxing the IRA

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jasonwc
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Re: Which of these horrible funds should my girlfriend choose for her 401k?

Post by jasonwc » Fri Jan 08, 2016 12:30 pm

jpelder wrote:
retiredjg wrote:I'd probably use the Washington Mutual Investors Fund at 1.39% and consider it all US stocks even though it has a bit of foreign stocks. It seems to be somewhat vanilla - large blend - and does not have bonds like some of the other funds.

Even a bad 401k is worth using if a person is going to move on to other employment. Especially if there is a match that will move than cover the higher costs.
:thumbsup to this. It looks like a large-blend fund that tracks the S&P 500 pretty well. But just do enough to meet her savings goals after maxing the IRA
Does it make sense to save in taxable if she can use the 401k to drop her into the 15% marginal tax bracket, reducing her capital gains rate to 0% federal, 5.75% state? This will be a temporary savings whereas the 401k is tax deferred until withdrawal.

retiredjg
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Re: Which of these horrible funds should my girlfriend choose for her 401k?

Post by retiredjg » Fri Jan 08, 2016 12:55 pm

I don't know the answer to that last question. It would certainly make sense to me to save the rest in taxable for her home downpayment - she'll get to that goal sooner or need to borrow less when the time comes.

Asking about saving in taxable for retirement is essentially asking if tax-deferral is worth it in the 15% bracket. I think it probably is, but not as much of a benefit as for someone in a higher bracket.

I'm curious about what others think on this.

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jasonwc
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Re: Which of these horrible funds should my girlfriend choose for her 401k?

Post by jasonwc » Fri Jan 08, 2016 1:08 pm

retiredjg wrote:I don't know the answer to that last question. It would certainly make sense to me to save the rest in taxable for her home downpayment - she'll get to that goal sooner or need to borrow less when the time comes.

Asking about saving in taxable for retirement is essentially asking if tax-deferral is worth it in the 15% bracket. I think it probably is, but not as much of a benefit as for someone in a higher bracket.

I'm curious about what others think on this.
The home down payment and full car cost is already covered.

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sometimesinvestor
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Re: Which of these horrible funds should my girlfriend choose for her 401k?

Post by sometimesinvestor » Fri Jan 08, 2016 2:25 pm

I agree with those who suggest investing to the point where you take full advantage of the match.I just think the employer should get more credit He is minimizing his cost so he can provide a match. Plus in general American funds are decent performers in spite of their high expense ratio which is actually low if you look at the funds generally suggested by paid advisors. While past performance etc (you know the drill) euro pacific is a decent international fund that often does as well or better than as the mscs developed index

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BolderBoy
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Re: Which of these horrible funds should my girlfriend choose for her 401k?

Post by BolderBoy » Fri Jan 08, 2016 2:47 pm

Even the money market fund has a hideous ER.

1. Does her 401k plan allow for "in service rollovers"? If yes, then contribute only to the money market fund and take rollovers as soon and as often as allowed (into her own, personal, low-cost retirement plan or IRA).

2. If #1 doesn't apply, gently advise the owner that he has a fiduciary obligation to the 401k plan participants and refer him to this SCOTUS decision: http://www.supremecourt.gov/opinions/14 ... 0_97be.pdf
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jasonwc
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Re: Which of these horrible funds should my girlfriend choose for her 401k?

Post by jasonwc » Fri Jan 08, 2016 3:00 pm

BolderBoy wrote:Even the money market fund has a hideous ER.

1. Does her 401k plan allow for "in service rollovers"? If yes, then contribute only to the money market fund and take rollovers as soon and as often as allowed (into her own, personal, low-cost retirement plan or IRA).

2. If #1 doesn't apply, gently advise the owner that he has a fiduciary obligation to the 401k plan participants and refer him to this SCOTUS decision: http://www.supremecourt.gov/opinions/14 ... 0_97be.pdf
While I agree that the fund choices are terrible, I think the employer is in a tough spot as there are only THREE EMPLOYEES in the plan, and the total plan assets are likely very small. If he went with one of the lower cost providers, he would pay between $1,000-$3,000 extra in recordkeeping fees, which is approximately $300-1000 PER employee.

In contrast, the plan offers a 4% match (about $2,200) as well as optional profit sharing, to be determined each year. Starting from $0, she would pay no more than $150 in ER the first year, and no more than $300 the second. Thus, she's clearly better off with the high ER funds + a reasonable match versus low ER funds + no match, which might be the result if the owner changes plans. The match makes more sense from the employer POV as the money is going directly to the employee. If he paid the recordkeeping fees and reduced the match accordingly, the lower ERs would only pay off for employees with significant assets in the plan.

As to your questions, the plan does not allow in-service roll-overs. I should also correct the post because my plan actually only has a 0.08% ER for the money market account. The 0.69 is gross but 0.08%.

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jasonwc
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Re: Which of these horrible funds should my girlfriend choose for her 401k?

Post by jasonwc » Fri Jan 08, 2016 3:01 pm

So, at this point it sounds like the best options are Washington Mutual Fund for domestic equity and Euro Pacific for international.

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Epsilon Delta
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Re: Which of these horrible funds should my girlfriend choose for her 401k?

Post by Epsilon Delta » Fri Jan 08, 2016 4:14 pm

A number of distinct points.

---
First I think it is a good idea to participate. Particularly as it is a small company. There is a good chance she won't be paying those expenses for long. Perhaps she'll leave and be able to rollover to an IRA. Or the company might grow and get access to a better 401(k) or it might shrink and terminate the 401(k) and she rolls over to an IRA. In my experience getting the money into the tax shelter is worth a few years of high expenses, particularly if there is a match.

---
Why do people thing the MM fund with an expense ratio of 0.08 is excessive? (Has this expense ratio been edited?) This MM fund is the clear winner in risk adjusted return across all the bond funds. It's probably the winner among all the funds. The MM fund should be used to the maximum amount compatible with the desired bond allocation and duration.

So what I'd do is set the target bond/stock asset allocation and a target duration for the bonds.

The MM fund has a duration of 0. Find a long duration bond fund to own in the IRA (I'd probably go with Vanguard long term Treasury at 15 year duration, but I would consider looking for a long dated zero fund with low expenses and a 25+ year duration). Figure out the proportion of MM/long term to get your desired duration then buy the MM/long term to fill your bond allocations. It's true that a barbell is not quite the same as a bullet, but it's not clear which is better and it is clear that using the MM fund meaningfully and surely reduces your costs.

I'd then hold my nose and fill the rest of the 401(k) with the cheapest reasonable stock fund. Probably Washington Mutual Investors Fund (RWMBX) (1.39) although I haven't researched it.

I'd use any leftover Roth IRA space to either tweak the stocks to undo any undesired tilt introduced by Washington Mutual or just use the total stock market.

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Epsilon Delta
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Re: Which of these horrible funds should my girlfriend choose for her 401k?

Post by Epsilon Delta » Fri Jan 08, 2016 4:18 pm

Epsilon Delta wrote:A number of distinct points.

---
First I think it is a good idea to participate. Particularly as it is a small company. There is a good chance she won't be paying those expenses for long. Perhaps she'll leave and be able to rollover to an IRA. Or the company might grow and get access to a better 401(k) or it might shrink and terminate the 401(k) and she rolls over to an IRA. In my experience getting the money into the tax shelter is worth a few years of high expenses, particularly if there is a match.

---
Why do people thing the MM fund with an expense ratio of 0.08 is excessive? (Has this expense ratio been edited?) This MM fund is the clear winner in risk adjusted return across all the bond funds. It's probably the winner among all the funds. The MM fund should be used to the maximum amount compatible with the desired bond allocation and duration.

So what I'd do is set the target bond/stock asset allocation and a target duration for the bonds.

The MM fund has a duration of 0. Find a long duration bond fund to own in the IRA (I'd probably go with Vanguard long term Treasury at 15 year duration, but I would consider looking for a long dated zero fund with low expenses and a 25+ year duration). Figure out the proportion of MM/long term to get your desired duration then buy the MM/long term to fill your bond allocations. It's true that a barbell is not quite the same as a bullet, but it's not clear which is better and it is clear that using the MM fund meaningfully and surely reduces your costs.

I'd then hold my nose and fill the rest of the 401(k) with the cheapest reasonable stock fund. Probably Washington Mutual Investors Fund (RWMBX) (1.39) although I haven't researched it.

I'd use any leftover Roth IRA space to either tweak the stocks to undo any undesired tilt introduced by Washington Mutual or just use the total stock market.
---
Basically you want to use the cheapest funds* that are compatible with your desired asset allocation. And it doesn't matter what the expected returns of the asset catagory is. Paying 1% on a bond fund which eats up the entire expected return is better than paying 1.5% on a stock fund even though the stock fund has an expected return of 6%. Expenses should be calculated in dollars, not as a fraction of returns.

* Technically it should be the cost in excess of the alternative in the IRA, but the alternatives in the IRA are all Vanguard index funds with a cost of ~0.15%.
Last edited by Epsilon Delta on Fri Jan 08, 2016 4:45 pm, edited 1 time in total.

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Epsilon Delta
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Re: Which of these horrible funds should my girlfriend choose for her 401k?

Post by Epsilon Delta » Fri Jan 08, 2016 4:20 pm

duplicate :oops:
Last edited by Epsilon Delta on Fri Jan 08, 2016 4:45 pm, edited 1 time in total.

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sunnywindy
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Re: Which of these horrible funds should my girlfriend choose for her 401k?

Post by sunnywindy » Fri Jan 08, 2016 4:43 pm

Since the funds are all about the same expense ratio, I would go to Morningstar.com and see how they rate the funds. They analyse the managers and the fund company, the two most important aspects of the fund. If they particularly like a fund, the give it a medal, such as gold, silver, or bronze. And don't pay too much attention to the star rating. It's not uncommon for a five star fund to run out of gas and then give one star returns for awhile.
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jasonwc
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Re: Which of these horrible funds should my girlfriend choose for her 401k?

Post by jasonwc » Fri Jan 08, 2016 4:45 pm

Given that she has 35-40 years until retirement, a 10-20% bond allocation should be sufficient. The entire bond allocation can easily fit in the Roth IRA, where the ER is 0.07%. The Money Market fund has returned exactly 0.00% for the last 1, 3, and 5 years. It's basically like keeping the money in cash.

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jasonwc
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Re: Which of these horrible funds should my girlfriend choose for her 401k?

Post by jasonwc » Fri Jan 08, 2016 4:54 pm

sunnywindy wrote:Since the funds are all about the same expense ratio, I would go to Morningstar.com and see how they rate the funds. They analyse the managers and the fund company, the two most important aspects of the fund. If they particularly like a fund, the give it a medal, such as gold, silver, or bronze. And don't pay too much attention to the star rating. It's not uncommon for a five star fund to run out of gas and then give one star returns for awhile.
The Vanguard research I have read suggests that the star ratings are at best meaningless, and potentially harmful as the highest rated funds are the ones most likely to underperform in the future, and vice versa. However, I wasn't aware that they awarded medals for factors other than performance (which is not a meaningful metric). What is the meaning of the bronze, silver, or gold metals?

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