Sizing Up Your 401(k)

Jason Stipp: I'm Jason Stipp with Morningstar. It's Tax Relief Week on Morningstar.com, and we're talking about your 401(k) plan today. It's a plan that's available to a lot of people, but is it something that you want to put all of your money into? It depends on a few factors, and Christine Benz is going to tell us a little bit about those. Thanks for joining me, Christine.

Christine Benz: Jason, nice to be here.

Stipp: So, a 401(k) plan is something that I get as part of my job, and it seems like a great way to invest. It reduces my taxable income now. But how do I really assess whether this plan is good for me and it's something that I should put all my retirement dollars into?

Benz: Well, the starting point would be a matching contribution. So, a matching contribution even on a lousy plan is well worth taking advantage of. So that's the first starting point. But then beyond that, you want to check up on the administrative costs associated with running the plan. A lot of people are surprised to learn that those plans oftentimes don't come free. So you want to check up on a document called a summary plan description, which should be available from your HR administrator.

So you want to look for administrative costs. Sometimes they're broken out as a specific line item. And I usually say if you see admin costs of more than 50 basis points, or 0.50%, that's a red flag that you're in a costly plan.

<TRANSCRIPT>

Stipp: OK. And what if I don't see any costs there on the plan, or it's not listed. How can I get a sense of the plan's expenses in that case?

Benz: Well, it might be that your plan doesn't have any administrative costs, and perhaps your employer, particularly larger employers, will just eat those costs for employees. But you want to take the next step, because sometimes the administrative costs, even though they're not broken out as a specific line item, are baked into the individual fund expense ratios. So you want to check on the specific share class that's in your plan. Hop on morningstar.com, take a look for the expense ratio associated with your specific share classes in your plan.

Stipp: OK. So I jump on Morningstar, I take a look at those. How do I know if it's high or low?

Benz: Well, I usually throw out, as rules of thumb, for bond funds expense ratios higher than 75 basis points. 0.75%. That's on the high side for a bond fund. And for equity funds, you might want to set the bar a little higher but not too much higher. So 1.25% would be at the high end of what I'd like to see in a 401(k) plan. If you're seeing a lot of funds with higher expense ratios than that, that's a red flag that you've got a costly plan.

Stipp: OK. I know there are a lot of different options and a lot of different plans. What if I come onto Morningstar, and I can't find anything about the options in my plan. Is that a bad sign?

Benz: Not necessarily. And this is increasingly common, where companies are using non-mutual funds in their plans. Sometimes they're hiring individual investment managers to run accounts specifically for the employees within that plan. Sometimes these can be very good, and if you have a large employer, they may have been able to swing a really nice, low expense ratio for this specific investment account. The downside is the transparency just isn't there, as is the case with mutual funds. So you've got to do more homework.

Stipp: So what sort of things would I look for in that case? I mean, could I go company-by-company, or how can I get a handle on whether, at least, I'm in good funds?

Benz: It requires some sleuthing. So one thing that you might look for is the management company of the fund, who is running the fund. So if you see Dodge & Cox, for example, is the manager, and it's a large-cap value fund, that's a pretty good clue that what's in your plan is probably a clone of Dodge & Cox Stock. So use management team, and cross-reference with mutual funds run by that same management team.

Stipp: Great. Well, some great tips. Christine, thanks so much for joining me.

Benz: Thank you, Jason.

Stipp: For Morningstar, I'm Jason Stipp. Thanks for watching.