Reader Question: What If My 401k Has Horrible Investment Options?

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Here’s another good reader question about crappy 401k plans. Reader Robert saves enough to max out his 401k each year if he wanted to, in addition to maxing out his Roth IRA every year which he already does. However, his 401k plan is filled with expensive actively-managed mutual funds. He has no company match. Should he contribute to his 401k anyway, or invest outside in a taxable account?

Factor #1: How Long Will You Keep Your Job?
Even if you have a bad 401k plan, remember that as soon as you leave that company, you can roll over those tax-advantaged funds into a Rollover IRA at the company of your choice! You may or may not have a good idea of how long you’ll stay there, but the fact is most of my friends have not worked at any company longer than 5 years or so.

(A few plans offer what is called in-service withdrawals, where you can roll over your 401k fund into a IRA without leaving your employer. These are rare, but it’s worth asking about.)

Factor #2: Can You Help Your HR Department Make A Change?
The reason why expensive 401k plans exist is because they tend to be cheap for the employer. Essentially, the administrative costs for running the plan are shifted to the employees. Big companies tend to have better plans because they offer enough assets for companies like Vanguard to jump in.

Still, you might be able to enact some change. Print out some material about how high plan expenses can really hurt performance and thus people’s retirements. Talk to your co-workers, and make it an worker attraction/retention issue. You may not need to switch providers, but perhaps they’ll at least offer a better option or two. I’ve even read about Congress considering a law requiring all 401k plan administrators offering at least one index fund option.

Factor #3: How Expensive Is It?
Unfortunately for Robert, he shared his available investment options along with their annual expense ratios, and they are the worst I’ve seen yet:

Blackrock Fundamental Growth C MCFGX 1.94%
Blackrock Global Allocation C MCLOX 1.88%
Blackrock Government Income Portfolio C1 BGIEX 1.53%
Blackrock International Value C MCIVX 2.60%
Blackrock Large Cap Core C MCLRX 1.97%
Blackrock Large Cap Value C MCLVX 2.00%
Blackrock Value Opportunities C MCSPX 2.34%
Davis New York Venture C NYVCX 1.71%
Evergreen Core Bond C ESBCX 1.45%
J P Morgan Dynamic Small Cap Growth C VSCCX 2.12%
Mfs Total Return C MTRCX 1.52%

It may be tempting to think “well, no matter how bad the plan is, it will still be better than a taxable account, right?” Wrong. Actually, given current tax rates, it can be better to keep your money in a taxable brokerage account than in a 401(k) plan if the options are expensive enough. Here are some quick and dirty examples.

Let’s say you put in $10,000 in a taxable account. You invest in an index fund with 0.20% expense ratio. The broad US stock market earns 8% per year. Since you get the gains minus expenses, you get 7.8% per year. You get a 15% tax hit at the end for long-term capital gains. Your final after-tax balance after 30 years is $80,906. (Yes, I’m ignoring the annual taxation of dividends for now.)

10,000 x 1.078^30 x 0.85 = $80,906

Let’s say you put in $10,000 of after-tax money in a Roth 401(k). You buy a Blackrock fund with 2% expense ratio. Again, on average, all mutual funds that invest in the broad US stock market will earn the market returns (8%) minus expenses (2%), giving you a 6% return per year. However, you have no tax hit at the end since it is a Roth. (You’d get the same result with pre-tax money in a Traditional 401k.) Your final after-tax balance is only $57,434.

10,000 x 1.06^30 = $57,434

The above is a very simplified comparison, but the point is that the gradual annual hit of a high expense ratio can overcome the tax break advantage. Usually this takes an expense ratio above 1% and a long time horizon.

Recap / WWMMBD
If you think that your current plan options will continue to be this bad for the next 10 years or more, and you don’t think you’ll leave your company before then, then it may indeed be better to just invest outside a 401k plan. (Keep up the IRA contributions!) However, I think that soon 401k plans will be more tightly regulated, and the trend is for plans to at least offer a few low-cost options. I know my plan seems to get a little better every year. If it were me, I’d probably suck it up and still tuck money away in the 401k in the hopes of a brighter future.

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  1. MoneyProgress says

    Great post 🙂 I’m in exactly the same situation. My company 401k plan stinks and has many of the same funds (blackrock) along with no company match. I also max out my Roth IRA. However, I’m not in a position to max out my 401k.

    I’ve done a bit of a compromise. My 401k contributions have been in the 2-5% range, nothing too high. I’ve tried to stash money elsewhere when I can, such as a SEP IRA, though my self employed income is low so I can’t put much here.

    In the end I think I’m banking on Factor #1, and then I will roll the 401k to my Roth IRA, as I have already done with my last job. Gotta love adding more to the Roth than the contribution limit!

  2. I am in exact same shoes as Robert. No 401k match and expensive funds – only two which seem worthwhile and I invest in: ESINX – S&P 500 index fund with 0.5% ER, all other fees waived and FKUSX – GNMA sort of bond fund with a 0.75% ER, all other fees waived. I concluded that I can live with these funds inspite the high expense ratios. Some other funds are good ones like American Funds, some Fidelity funds etc but still an ER over 1%. I wrote repeatedly to the 401k administrator. From the responses, I understood how the plan worked and what the limitations are. I may get to be on the 401k committee soon. I will let you know if and when that happens and what it results in.

  3. One point that is missed is the Roth 401k will be non-taxable when withdrawn, where as the taxable account will be taxed at normal income rates (or matched up with losses on sch. d). So it would depend on how long the individual plans to keep the money there as well as the fact that tax rates may fluctuate in the future(probably higher). Just something to think about.

  4. I have been thinking about this lately, should the situation arise once I am finished with grad school. This idea is pretty nontraditional and I am not well versed in the rules of 401ks. So if anyone is more knowledgeable, feel free to run this idea through the gauntlet to make sure it passes the test. Here it goes:

    One option would be to take a loan against your 401k and invest it in your taxable account (interest bearing savings, CD’s, brokerage, etc). You could pay back the loan with the same money you just took out, or from your monthly income.

    -This may also be a way to increase your yearly 401k contributions above the maximum, if you are paying the loan interest to yourself
    -You are in control of your money
    -Investment choices may be far greater

    -Paying taxes on your earnings
    -Paying taxes twice on the loan interest
    -You could lose money in the stock market
    -You have to come up with money each month to pay back the loan
    -You could lose your job and have to pay back the balance within 60 days.

    This strategy may be pretty advanced, so use your own risk assessment as to how and where to invest this 401k loan.

  5. Factor #4: Can you do in-service rollovers?

    This is when you roll your 401k assets into an IRA while still employed. Few plans allow it, and it may only apply to a Roth 401k or a traditional 401k (I’m not sure because I’ve never actually looked into it).

    If it’s permitted, you can just roll over your entire 401k balance to an IRA every quarter or something like that. I’ve heard of someone doing this, maybe on the Bogleheads forum.

  6. But if your company matches, doesn’t it seem like a good idea to pick the fund with the lowest expense ratio and at least contribute up to the match?

  7. Investing in the index seems like a wiser decision. This was a good article.

  8. to make it worse, the funds are often of a unique share class such as R-1, R-3, etc. that cannot be matched to any publicly traded funds easily. My companies fund expenses are ok, being around 1.5% but we have to add two expenses together to get the real number. the second one is in the fine print. the first one is listed clearly on the summary sheet for each fund choice. Almost nobody in my company realized there was a second expense added depending on the fund company.

  9. This is the Robert that the post was about.

    Thank you so much Jonathan. This was very helpful and informative.

    Couple things:

    @DaveD – Without a doubt, I’d contribute IF there were a company match. But of course, there isn’t.

    @Jonathan – Since I sent you that e-mail, I’ve done a lot of investigating and there is one fund that wasn’t displayed in the initial offering.

    It’s the Davis New York Venture A NYVTX (0.85%)

    Expense ratio is much better.
    I’m considering just putting 100% into that.

  10. I agree with DaveD – if the company does matching, then it still makes sense to contribute *Up to the match amount*.

    Say, take the typical matching scheme:
    The company matches 50% of your first “X” in contributions (let’s say “X” is $10,000 since your example used that.

    If you put it in the regular taxable account, you would have $80,906.
    In the Roth 401(k):
    (10,000 x 1.5) x 1.06^30 = $86,151

    So, you come out ahead, AND you get the benefit of being able to switch the whole pile of money to a better option if/when it becomes available. Also, if your time horizon is less than 30 years, you will come out significantly ahead.

  11. Robert (a differen't Robert) says

    I feel lucky reading this. My company matches 50% of first 6% and we have some low-cost index funds in the mix. I don’t think I’d contribute if the company didn’t match AND the options were that bad. Blackrock is making a killing with their high fees.

  12. I was on the committee to choose the investment options at our university. I convinced the other members to remove the eggregiously expensive options from our plan. The vendors said they would sue us, and the university caved and we kept them all.

    Naturally at the benefits fair yesterday all the worst vendors were in attendance and the best vendor was nowhere to be seen. That can only mean more individuals suckered out of their money (my opinion of course).

  13. I think you need to do your research before you start bashing actively managed mutual funds. You are giving advice that is extremely “general” and “vague” and, unfortunately, is not very helpful. Based on your argument of index funds, let’s take a look at the S&P 500. Over the past decade, aka “The Lost Decade for Equities”, if you purchased an inexpensive S&P index fund, you rate of return would be approximately a cumulative -15%.

    Now let’s take a look at one of the investment options that you have listed above, BlackRock Global Allocation. With an expense ratio of 1.88%, the fund has generated an approximate cumulative return of 110%. THIS IS AFTER FEES and if did so with a lower standard deviation than an equity index or fund. Hmmm, let’s think for a second. Do I want to buy an index fund, pay 0.20% in fees, but have a negative return, or do I buy an actively managed asset allocation that has more than doubled my money over the past 10 years.

    Please do your research before you post these types of articles.

  14. Morningstar had an article about this today that had some good tips:

    My plan includes a 1.5-2% fee range for the majority of the offerings which I think is ridiculous since they are almost all sub-par funds. At least the plan has a company match (or I wouldn’t be participating), and they finally added a couple index funds so it’s not nearly as bad as it was.

  15. 401k Rollover School says

    @Don – do you mind telling us what university that was?

    Investments with high expense ratios are the last option for any investor. there are so many good investments that have low expense ratios, I don’t know why anyone would invest in anything else.

  16. @Zach – Don’t forget about long-term capital gains and the dividend tax rates. These are often much lower than ordinary income rates.

    @BC – I’m not sure how the math would work out on that one. Depends a lot on the interest rate * income tax rate.

    @John Doe – Do you also like to drive using only your rearview window? Seriously, with a 2% expense ratio headwind, I’d be willing to bet any amount up to $10,000 that Vanguard Total World ETF (VT) beats BlackRock Global Allocation over the next 30 years, if the latter is even around then. You have to decide now though, not wait until 30 years later and look backwards.

    Re: Match – Yes, I would agree one should still contribute up to the match as that “free” money would overcome just about any expense ratio. Unfortunately, the reader indicated a match was not available.

  17. The Morningstar article is timely, the tip about using the brokerage window is possibly useful if it is available.

    @Robert – According to Morningstar, NYVTX may have a front-end load of 4.75%, though it might be waived inside 401k plans. Otherwise, it could be the best choice available.

  18. Chris Brown says

    I have an unrelated question about 401k loans. Is it ever a good idea to take one? I have a friend, paying rent, and wants to use the money in her 401k for a 20% down payment. She is 10-15 years away from retirement and has a stable job. Her chances of loosing her job are very small. I’m a firm believer that paying rent is a very bad idea in almost any circumstance and if she were to try and save the 20% up first, she would be paying rent the whole time. Can someone recommend a course of action?

  19. Jonathan,

    I’d bet you a million dollars that even with a 2% expense ratio, MCLOX will outperform the Vanguard Total World ETF, VT in a rolling 3, 5, and 10yr time period. It’s not how your perform in bull market, but how much money you lose in a bear market.

    MCLOX is a diversified, global flexible allocation fund. It has a strong focus on downside protection. Perhaps you’d like to look at Ivy Asset Strategy, WASCX, or perhaps First Eagle Global Allocation, FESGX. These two funds implement the same strategy. Hmmmmm, notice something in common???? THEY ALL OUTPERFORM EQUITY INDEX FUNDS!!!!!!!

    Your rearview investing comment holds no water and highlights a significant lack of understanding. It is a shame that there are a plethora of sub-par mutual funds but that doesn’t mean you can’t find great funds. Just look at the three above my friend.

    Best of luck making money in your index funds. Hope you aren’t planning on your social security payments. We all know where that program is headed.

  20. @John Doe – Okay, I guess this probably won’t happen, but I was being serious here. Shorter periods leave too much to luck. Make it 15 years and anything up to $5,000 cash, and you’re on. Winner can then play the World Series of Poker that year. 🙂

    Update: If we agree to give proceeds to charity, we can use like Warren Buffett.

  21. I have exact same choice + couple others expensive options! 🙁


    Where is this anonymous “John Doe”….? Don’t go running with your tail between your legs now. 😉

  23. Jonathan. I’ve been reading you blog daily for 4 years and like many of the things you post. Good job on pointing out the possibility for an in-service transfer and the fact the employees should reach out to HR for a change. There is something strange with the selection.

    The two big problems I see with the 401k options are: 1) These are all C shares and 2) they are concentrated in Blackrock. This tells me that the 401k plan provider might be lazy in selecting funds. Also, the 401k is probably small because they are not using R class and the company 401k HR/admin probably did not want A shares because of the up front loads. Odds are even if the employee’s pooled contributions, the total couldn’t lift them out of the first couple of break points.

    John Doe is right about MCLOX. It’s a great fund that has managed its assets very well over the past decade. Check its performance against the S&P in the tech bust and during the past market meltdown.

    I don’t buy/invest in something just because it is cheap. I buy something because of its quality. An example for Robert: He complains about the annual expenses BUT he will invest in NYTVX. Look at how MCLOX did vs. NYTVX in the 2008 melt down. (-21.21% vs. -40.87%). Yeah you saved on the expenses at the cost of losing your shorts. Don’t lose sight of the forest for the trees. I personally own the A share class of the fund and think Dennis Stattman earned his fees last year.

    It’s boring to hear the index vs. actively managed fund banter. Those that want to do it themselves and feel all loaded, actively managed funds are rip offs to enrich the advisors should be investing in a diversified portfolio of index funds. Those that research active managers to understand their investing philosophies and crunch the numbers should venture out to active managers. (One mutual fund family comes to mind where I’ve personally ran 10 years rolling periods comparing their equity funds to the S&P 500. The actively managed funds outperformed AND their annual expenses are some of the cheapest of actively managed funds.) There are MANY terrible actively managed funds out there but there are some that have a history whose investors have reaped the benefit of good management.

  24. The one thing most people don’t consider in a 401K (and other mutual fund holdings) is the ability to go to money market duing bear trends.

    Something as simple as a 100 day moving average on the market – which most institutional traders keep an eye on, would have dictated an exit when it began to trend downward in late 2007.

    It began rising in May of 2009, which signaled a re-entry into growth funds.

    It’s not perfect, but it doesn’t take a lot of time to monitor and it would have saved most of the losses during the great decline, and allowed the investor to buy with MORE money at the March-May lows.

    Not being in when a fund is losing big, is just as important as how a fund performs in a bull trend.

    That’s real compounding!!

  25. John Doe and Aristotle,

    I think the argument here is not about active and index funds, but about expenses. Also, your comparisons of balanced active funds (MCLOX holds only 58% in equities and the rest in cash and bonds) to purely equity-based index funds are somewhat disingenuous. A balanced fund is obviously going to have a lower downside in a bear market than a stock-only fund. By that token, I could argue that VBMFX (total bond market index fund) has generated a 10-year return of 80% at a far lower expense ratio and risk level than MCLOX (which fell 26% between Aug-Nov 2008 vs. 3.5% for VBMFX – cherry picking time-frames is fun!).

    It’s easy to look at past performance over specific periods and cherry-pick a few actively managed funds that have beaten index funds with equivalent stock/bond/cash allocations. Given that past performance is not a predictor of future returns, what is your rationale for investing in an expensive active fund vs. a low cost index fund?

  26. I invest in both index and managed funds. Cost is a number one concern of mine, and helps to narrow the vast playing field. I mean really, how many mutual funds are out there??? There are quite a few excellent managed funds with no loads, that don’t cost an arm and a leg. Looking for value doesn’t mean sacrificing quality, to me.

    BEing a tax advisor, I’d add one thing to the post. If you are in a low tax bracket (like 15%), I wouldn’t see the allure in investing in bad 401k funds. I agree with going for the match, but that’s about it. If you were in a high tax bracket, I would consider putting more money in the 401k. You could save a fair amount of taxes, and hope to roll it into an IRA some day. Just to point out, your tax situation would really sway your decision.

  27. Original Robert again here!

    As it turns out, the load on the Davis NY A fund is waived, so I think I’m going all-in on that one.

  28. Just started a new job. No matching contributions by the employer to the 401k and few funds to choose from. Why not open an IRA with vanguard instead?

  29. Why a 401(k) is better than After Tax investing:

    1) Traditional 401(k) has an immediate benefit of what you don’t pay in taxes (i.e. you can fund more Traditional 401(k) then aftertax counterparts if your income is limited) – that money compounds year after year in the 401(k).
    2) Roth 401(k) has unlimited tax-free gains
    3) Both can be converted to IRAs when you leave the company
    4) Time Limits, you can only fund a 401(k) during the year you earn the money, once that year is over – your chance to protect it from taxes/lower your taxable income is gone.

  30. Addressing the premise of this particular post, horrible options, I do recommend asking the plan administrator, “What percentage of my 401(k) can rollover through in-service distribution?”. Many employees do not know to ask, and it is often not advertised.

    Rolling over a portion (usually 50% I’ve found), of one’s 401(k) into a self-directed IRA opens up the whole world of investment choices for the participant, allowing them align their investments with their values,risk tolerance and time horizon. Clearly a winning strategy if allowed.

    The caution, however, is now you must chart your course through the often stormy waters of The Stock Market. Best to seek some un-biased investment advice and avoid getting “sold”.

  31. Tim Fischer says

    Most folks don’t understand that companies have a choice between choosing low-cost 401k plan administrators (like Vanguard and Fidelity) and those that charge higher-loads and fees. The reason that most only offer the latter is because it’s free to the company. I.e., they are not required to pay any administrative fees to the fund -because their employees are paying in higher fees.

    Our company was in the process of choosing a 401k plan and we vetted a number of the different options. The slimeball reps from the high-load funds kept telling us we’d be crazy not to go with them, since our employees would never know the difference and the company would save money. We threw them out by their ears and ended up going with Fidelity. They charge a small administrative fee to the company, but all of their funds are no-load and have small expense ratios.

    If your company is only offering loaded funds, they’ve already made the decision on who is really paying for administering your retirement funds, while tying your hands on your options.

  32. In-service withdrawal is not allowed by law for employee money before 59-1/2. No qualified plan can offer that. It’s allowed by law, but not necessarily by the plan, only for employer money (match, profit sharing, etc.) or after 59-1/2.

    I made a spreadsheet that calculates if it makes sense to forgo the 401k and invest in a taxable account instead when there’s no match. Usually the 401k is still the better choice than taxable after you are done with your Roth IRA.

  33. TFB, I appreciate you sharing your spreadsheet; I’ve got a question or two and like to chat more about it if you’re willing.

    Thank you,


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