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Here’s a 401(k) gotcha: Mutual fund companies favor their own funds, especially low-performing funds, in setting 401(k) investment menus . That means they may not be your best choice for building your retirement nest egg. That’s the conclusion reached in a new study that will be appearing soon in the Journal of Finance: It Pays To Set The Menu: Mutual Fund Investment Options in 401(k) Plans. A shortened write-up for the Center for Retirement Research at Boston College asks: Are 401(k) investment Menus Set Solely For Plan Participants? No, the authors conclude. Mutual fund company involvement in 401(k) menu line-ups appears to favor proprietary funds—to the potential detriment of retirement savers, the authors conclude.
The study doesn’t name any funds, but the question for investors is: if NAMEYOURMUTUALFUNDCOMPANY administers your 401(k) should you choose NAMEYOURMUTUALFUNDCOMPANY funds when picking your 401(k) investment line-up? Maybe yes, maybe no. Despite the fact that these plans are covered by ERISA laws meant to protect retirement investors, it’s another lesson of buyer beware.
Mutual fund companies are acting in ways that appear to advance their interests at the expense of employees saving for retirement in the plans, the study says. It covers plans serving 9 million employees who held one-third of retirement assets in plans sponsored by publicly-listed companies. Three-quarters of the plans had trustees affiliated with mutual fund companies. Most, however, have what’s known as an “open architecture” plan that includes funds from unaffiliated mutual fund companies as well. That allowed for an analysis of how the same fund is treated when affiliated or non-affiliated.
Mutual fund companies were less likely to remove their own affiliated funds from the plan line-up compared to unaffiliated funds. Worse, the bias in favor of affiliated funds if stronger for funds that perform poorly. The deletion rate for affiliated funds in the lowest performance decile was 13.7% compared to a 25.5% deletion rate for unaffiliated funds in the lowest performance decile.
In addition, there was a bias towards adding affiliated funds to the fund line-up. And the bias was especially pronounced in favor of funds that delivered sub-par returns over the preceding three years. Basically, decisions to add funds to the menu were less sensitive to past performance for affiliated funds than for unaffiliated funds.
Unfortunately, the 401(k) participants did not offset this bias by directing their savings away from favored affiliated funds. To make matters worse: Poor performance of sub-par affiliated funds was found to persist. Any underperformance of the funds—especially if compounded to retirement—would impair participants’ retirement income security.
So what should employees do? Know the bias is there when making your investment line-up choices. Take a hard look at your 401(k) offerings, and determine what mix works best for you: actively managed funds, index funds, ETFs, or even going through a brokerage window if your plan offers one. A fee-only financial planner can help.[/entity]
The authors of the study are Veronika Pool, associate professor of finance at Indiana University’s Kelley School of Business, Clemens Sialm, professor of finance at the University of Texas Austin’s School of Business, and Irina Stefanescu, economist at the Federal Reserve.
