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Improved 401(k)? Who can tell?
Fund line-ups are changing. If Time Warner's plan is any indication, the changes may be baffling.
October 5, 2005: 11:40 AM EDT
By Jeanne Sahadi, CNN/Money senior writer

NEW YORK (CNN/Money) – Which would you prefer: a restaurant that offers a select number of well-prepared entrees or a menu with listings that rival the number of words in the dictionary?

Personally, I prefer the first option. Too much choice exhausts me.

So you'd think the move made by Time Warner, my employer, to simplify and reduce my 401(k) investment choices would delight me.

It might, except I've had the hardest time figuring out just what exactly the changes mean.

I bore you with this for one reason: Time Warner's plan may be the wave of the future, 401(k) experts tell me, at least at large companies.

I suspect my mystification is due mostly to the ample but confusing and not-always-informative marketing materials sent to employees. I imagine corporate communications at other firms making similar changes won't be much better.

So I tried to get some basic questions answered that would benefit anyone facing a similar changeover.

What your 401(k) may soon look like

Time Warner changed its investment line-up in two ways:

First, it reduced the number of investment options from over 100 to just 17. In the past decade, the thinking in the 401(k) industry has been "the more choice, the better," said David Wray, president of the 401(k)/Profit Sharing Council of America. But now the thinking is too much choice causes deer-in-the-headlights syndrome.

The 17 funds in our plan cover the basic asset classes and investment styles to create a diversified portfolio. So if you know your desired asset allocation, it's easy to pick the funds you need.

The second change was more significant in my view. Rather than continue to offer publicly traded mutual funds, Time Warner is offering mostly separately managed accounts and commingled funds, which are not publicly traded.

That means they are open only to Time Warner employees in the case of separate accounts, or to the employees of a handful of companies, including Time Warner, in a commingled pool.

"There's clearly a trend away from retail mutual funds to more institutionally managed funds," said Harold Small, a principal of the 401(k) advisory firm FiduciaryVest.

Here's what that means to you and me in terms of:

Costs: The expense ratio you pay to invest in a fund reduces your net return: the higher your expense, the less money you make.

Institutionally managed funds tend to be much less expensive than publicly traded ones, since your employer has more leverage to negotiate fees.

Lower costs can mean we get to keep an extra few hundred dollars a year in our accounts, which, compounded over time, is not insignificant.

Performance and track record: What most concerned me about our new fund lineup was that there was no past performance data or lists of holdings for most of the new funds.

Past performance may be no guarantee of future results but it gives you an idea of how a fund performs in good times and bad.

In terms of holdings, I'd like some assurance that my money won't be too heavily invested in any one company when I look at my portfolio as a whole.

According to Small, a company would likely hire an investment firm to run a particular type of fund (e.g., small cap blend) in which they have a good track record. The holdings in that fund are likely to replicate about 90 percent of the holdings in a comparable retail fund run by the same investment firm.

So you might use information on that publicly traded version as a proxy, until your fund starts reporting performance and holdings.

Transparency: You can't look up information about non-public funds at fund trackers like Morningstar or in the press. So you are reliant on your employer and its investment service providers to give you the information you seek. Typically, performance is reported quarterly, Small said, even though fund shares are priced daily.

What should you do?

Before hiring outside investment managers, your employer has the responsibility to ensure they'd act in the best interest of plan participants, said Rick Applegate, a 401(k) adviser and certified financial planner. And your employer needs to continue monitoring the investment managers' performance once they are hired.

Despite my grousing, I'm somewhat confident Time Warner has done a reasonable job picking decent investment managers who can provide reasonable returns.

"You should spend no time whatsoever wondering if those funds are good for you, once you're confident your employer has done the proper due diligence," said Wayne Bogosian, president of the Personal Financial Education Group.

I'm influenced, too, by studies suggesting that over the long term it's less important what individual funds you invest in (save the true dogs) than that you maintain a diversified, low-cost portfolio and invest money steadily over the years.

But some of my colleagues are having none of it. They like the old plan and they don't want to give up the funds they were invested in. So they've decided to open self-directed brokerage accounts through the plan. Those accounts let them invest in a wide array of publicly traded mutual funds.

There's an account maintenance fee and the expense ratios of the funds they invest in are likely to be higher than those in the plan.

There are two reasons to opt for a brokerage account, Small said.

  • If you want exposure to investment strategies not available within your plan; or
  • If you think you can get better returns and/or less risk from funds with similar strategies to those in the plan. But the rewards have to be high enough to more than offset your additional costs to use the account.

Whether you choose to invest inside your plan or out, you first should figure out how much you can contribute and what target rate of return you'll need to achieve your long-term goals based on your contributions, Bogosian and Applegate said.

Then create a portfolio that gives you a good chance of achieving that, but which also suits your risk tolerance and time horizon.

In my case, I'm first going to dig through the marketing materials again to see if I can intuit what the heck it is I'm really getting myself into.

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Jeanne Sahadi writes about personal finance for CNN/Money. For comments on this column or suggestions for future ones, please e-mail her at everydaymoney@cnnmoney.com.  Top of page

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