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Lightening the 401(k) load
My 401(k) has load funds. I'm concerned they will restrict the growth of my 401(k). Should I worry?
September 18, 2002: 1:23 PM EDT

NEW YORK (CNN/Money) - My company's 401(k) plan has load funds. I'm concerned that these 5 percent loaded funds will restrict the growth of my 401(k). But when I asked a representative of the fund company about this, he told me the funds offer a higher return because of their aggressive nature.

Am I being too particular or should my company be looking for a new fund company that can provide no-load funds for our plan?

-- James Blarr, Red Bank, New Jersey

I don't think you're being too particular at all. In fact, I think you're asking all the right questions, and I think you deserve better answers than the completely irrelevant one you got from the guy at the fund company.

Let's start with the issue of loads. For anyone not familiar with this term, a load is a sales commission. If a fund charges a 5 percent load, as do the ones in your 401(k), that means for each $1,000 you contribute to your plan, $950 gets invested. The remaining $50, the commission, normally would be split between the fund family, which uses the money to pay marketing and distribution costs, and the salesperson -- usually a broker or financial planner -- who sells the fund.

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In the case of your 401(k), however, I don't see how a financial planner or broker would be involved. Which raises an obvious question: Where does the 5 percent commission go? Does the fund company get the whole thing? Does your employer get a share?

I suspect that the load is being used to shelter your employer from some of the cost of providing the 401(k), which is another way of saying it's shifting the cost to the employees. That's not typical -- many plans waive loads for participants. But it's not unheard of, either. Sometimes, in the case of a small company, for instance, when the employer can't afford -- or doesn't want to incur -- the cost of offering a 401(k), the loads are used as a way to pay the provider for administering the plan.

Weighing down growth

Now let's get to the issue of whether or not paying a 5 percent load restricts the growth of your 401(k). Of course it does! This nonsense about the funds paying a higher return because of their aggressive investing strategy only obfuscates the issue.

Let's say you have two identically aggressive funds that earn identical returns, but one charges a load and the other doesn't. Obviously, the account value of the no-load fund would grow faster because 100 percent of your money is going into it as opposed to just 95 percent, which is what you have left to invest in the load fund after paying the 5 percent sales charge.

Of course, the purveyor of the load funds you spoke to might argue that my example of two identical funds is nonsense, too. He may say their load funds are so superior that they outperform no-load funds and, thus, more than make up for the load. Is that possible? I suppose. But I know of no evidence that shows load funds perform any better or any worse than no-load funds, or vice versa.

And why should they? You pay a load to reimburse the fund company for marketing costs and to pay a salesperson for advice and assistance in choosing a fund. The load isn't an incentive to the manager picking the fund's investments. And even if it were, I know of no evidence showing that a fund manager with such an incentive is likely to outperform other managers.

Which brings us to what really bothers me about this load arrangement in your 401(k). I have no problem with someone paying a load for a fund if they are getting good advice or some sort of service. I wouldn't pay a load because I believe I can do my own fund research and build my own portfolio. But for those who can't or won't do it on their own and want professional help, then they've got to pay for that help. The load is one way of doing that. (I think there are plenty of instances where people don't get very good help, but that's another matter.)

So my question here is, what help are you getting for the load? Are there seminars or face-to-face meetings with investment counselors? Are they helping you build a portfolio of funds? If the answer is no, then I question what value you're getting for the load. And even if the answer is yes, I question whether a load is a good way to pay for such advice. After all, in your 401(k) everyone pays the load whether he or she wants the advice or not. And everyone pays the load every time he or she invests in the plan's funds.

Arm yourself with information

If I were you, I first would check out some of the information available from the Department of Labor on 401(k) fees. This will give you a sense of the variety of different arrangements out there and let you know how yours compares.

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Next, I would talk to someone in your personnel or human resources department about the load issue. It probably wouldn't hurt if you had a group of employees do this, so you don't seem like a lone malcontent trying to stir up trouble.

At the very least I would ask for an explanation of why your 401(k) has this arrangement. And I don't see why it would hurt to request that your company add some no-load funds to the lineup. The worst your employer can say is no.

Walter Updegrave is the author of "Investing for the Financially Challenged" and can be seen regularly Monday mornings at 8:40 am on CNNfn.  Top of page

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