The Coming Crisis in 401(k) Fund Choices

Think about the choices in your 401(k). You probably have a long list of stock funds, maybe two general purpose bond funds and a list of target date funds that combine stocks and bonds. Essentially, all you can invest in is a combination of stocks and bonds. That’s it. Sure, you have a stable value fund or money market, but what is it paying? – probably less than the rate of inflation. Your only growth choice is some combination of stocks and bonds.

In this crazy post-2008, post-Brexit world, that’s likely to be a big problem, because bonds are getting pushed to nosebleed-level prices. About 1/3 of all debt issued by high quality sovereign nations is now selling for prices that result in negative yields. In other words, investors are paying so much for bonds that when they get back the face value of the bonds at maturity the extra price they paid to buy the bond is more than all the interest they get. Institutional investors are chasing high quality bonds so hard that they are willing to lose money to own them if held to maturity.

Why on earth would any investor be willing lose money buying bonds? The only reasons I can think of are (1) that they need to own bonds (insurance companies, banks and those with fixed allocation to bonds like pension plans), (2) they are so afraid of what’s next that they will only buy government bonds or (3) as prices have gone even higher, they are seeing capital gains on the bonds.

When this extreme situation stops, those general bond funds in your 401(k) lineup may be worthless as investment choices, or worse. When rates finally do rise, many if not most bond funds may lose money for awhile. Their only significant income will likely come from junk bonds and international bonds. That is, if they are allowed to invest in them and if they are not falling in price as well. If you have a bond index fund, it cannot adjust because it has the least flexibility – zero.

This is far from ideal for your participants. Plan sponsors really need to wake up and smell the coffee. One decent growth investment class (stocks) is not enough, especially in this nearly stagnant, low-growth world where stocks sell above their historical averages and corporate profits are declining. There are numerous alternative funds and sponsors need to start considering adding these to the 401(k) lineup.

If you have a say in the management of your plan, it is time to get busy taking a hard look at plan investment choices. The stakes are about to get much higher. The time to just go along with the list your bundled plan provider gives you is over. It is time to look at alternative funds and custom target date funds that can use them.It takes time to do the research and come to a prudent decision.

It also takes a plan investment advisor that is savvy on these issues, not just a financial planner or insurance agent that has lucked into a couple retirement plans as a sideline. If that is who you have now (do you even know how many plans your advisor manages, whether he is bonded for retirement plans, how much continuing ed he does that is specific to qualified retirement plans, how much he charged the plan last year, etc.?) you should think hard about replacing him with an advisor that is a retirement plan specialist that can help you significantly improve your investment lineup for the good of your participants and for your protection as the one with liability for prudent plan management.

 

 

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