The “Cost of the Problem” Improves 401(k) Mutual Fund Choices

How much does it cost to make the wrong 401(k) mutual fund decision? Hint: it’s more than you think. Here’s how to make sure you’re making the best choices when it comes to your 401(k) mutual fund picks.

Funding your 401(k) to the maximum amount each year is the easy part. Taking a hands-on approach to managing your 401(k) is more difficult.

All of the company 401(k) provider propaganda in the world regarding asset allocation, diversification, and auto-enrollment does not answer the most basic investment management decision asked by the majority of 401(k) participants: What do I buy?

I have reviewed hundreds of individual 401(k) account statements from hundreds of company 401(k) mutual fund menus. I see the same 401(k) investment management decision mistakes made repeatedly. Most 401(k) participants attempt to diversify using some back-of-the-envelope level of “asset allocation.”

The end results are predictable: Small positions that lag the stock market averages. Even worse are the popular target-date mutual funds, which have been hyped as a “set-it-and-forget-it” solution.

In many 401(k) retirement plans, a target-date mutual fund is the QDIA (Qualified Default Investment Alternative). When you contribute to a 401(k) plan, you need to direct those contributions to a specific mutual fund option. If you don’t, your 401(k) retirement plan contributions, and company-matching contributions, are directed into a QDIA mutual fund.

Pay more attention to your 401(k) mutual fund choices. Don’t settle for someone else making your investment choices. It only takes a little time and homework. Regardless of the number of mutual fund options on your 401(k) menu, there are no more than a handful of funds that outperform. More importantly, this same handful holds their value much better during stock market declines.

If you are going to take all the risks associated with stock and bond market investing, doesn’t it make sense to put your 401(k) in a position to receive commensurate investment returns? The best way to answer the “what do I buy?” question is to calculate the “cost of the problem.” I developed this tool to help 401(k) participants understand exactly how much it has cost them to own the wrong mutual funds.

There is always a huge investment performance gap between the best and worst mutual funds on your 401(k) menu. The problem is that no independent third party has ever helped you calculate the dollar value of that gap. If you ended up putting a dollar value on your poor 401(k) mutual fund choices, you will be amazed and more motivated to do something about it.

The “cost of the problem” analyzes the financial consequences of a lack of informed fund choices. Over your working career, there is a huge dollar amount of financial impact of owning the wrong mutual funds.

Here’s how to do it.

Find the information on the last three, five, and ten-years investment performance on each 401(k) mutual fund option.

Next, calculate the value of a $10,000 investment at the end of each of those periods.

A $10,000 investment in one of your best 401(k) mutual funds would be worth 30 to 40 percent more than the same dollar amount invested in one of the mutual funds you currently own over the same time period.

Every 401(k) investor is capable of this same level of investment management decision-making. Each time you receive your quarterly account statement, take ten minutes to identify the names of the top handful of mutual funds ranked by recent investment performance.

Divide your company 401(k) mutual fund menu into two groups: those mutual funds that have outperformed and those that have not.

Make sure that all your 401(k) mutual funds remain invested in the top three or four of your options. Once those top mutual fund options are identified, then you can think about asset allocation and diversification.

The “cost of the problem” calculation results in a much more profitable long-term buy-and-hold 401(k) investment management strategy.

Would you be willing to take ten minutes every calendar quarter to have significantly more money in your 401(k) on your desired retirement date?

You no longer have to guess “what to buy?” in your 401(k). You just need the dollar value calculation of your previous 401(k) mutual fund decisions versus better 401(k) mutual fund decisions.

Pay attention on a regular basis to your 401(k) mutual fund rankings either with your paper quarterly statements or a few minutes online.

Improve your chances to be a long-term 401(k) investment management winner. The growth and preservation of your retirement nest egg will not be assured but it sure as heck will be better than many of your peers.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.