What Your Company Is Not Telling You About the 401 K Plan
Employers are making changes left and right to their 401 K plans. Why are they doing it and is it a good idea for the employee?
Here is what you need to know:
1) 401 K plans are scared of liability of their fund choices - Companies are looking hard at what they are selecting as 401 K investments for their employees. Employees in turn are suing their companies stating that the company is not acting in the employees best interest mostly based on under performance and loses. So, many 401 K plans are putting together 401 K plans offering choices that aren't really good choices. However, it does help mitigate liability for the company.
2) 401 K plans are gravitating towards retirement date funds - They are called Freedom funds, lifestyle funds, target date funds, etc. Each fund company calls them something different. They are suppose to decrease risk for the employee be reducing risk as they get closer to retirement. For example a fund dated 2030 (retirement date year 2030) takes a reasonable amount of risk based on where the employee is in relation to retirement. As the employee gets closer to retirement, the risk gets reduced. However, what many of these funds are doing, is increasing risk in order to get bigger returns. A recent article showed that the Fidelity Freedom fund 2020 (2 years from retirement) was taking way more risk than it should be. This was also evident during the 2008 financial crisis as these retirement date funds accumulated unreasonable losses based on the date of retirement. Is this a really good choice for the employee? I don't think so especially when the fund is not staying true to their mandate of reducing risk as the employee gets older.
3) 401 K plans are gravitating towards passive index funds - These types of funds greatly reduce the liability for companies because these funds are set up to mimic the investment index that they represent. For example, say you have a Dow Jones industrial fund. That fund is designed to mimic the Dow Jones. This choice versus an actively managed fund that is designed to do the same thing but greatly under performs the Dow Jones. The company chose the actively managed fund and the employee is suing over its performance.
Passive funds assume 100% of the risk of the index that they represent. For employees that don't want to take a lot of risk, passive funds are not a good option. Is this a really good choice for the employee? I would say yes for employees who just want to take the same risk as the market. No, for those who are risk adverse. The reality is that there are more and more people who fit that mold today.
Bottom Line - First, I think that employees need to take responsibility for their choices of funds versus filing lawsuits. These lawsuits in most cases are ridiculous. Second, these changes made by 401 K plans beg the question - is a 401 K plan the right investment vehicle for me? Times are changing and maybe traditional choices for retirement should be also.