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Is Your 401(k) Failing You?

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Ah, the joys of the 401(k) plan! It's a seemingly easy solution to your retirement needs. Just sign up once, then conveniently contribute automatically every month. Better yet, your contributions are all made with pre-tax dollars, lowering your eventual tax bill. What's not to love?

As it turns out, quite a lot.

The cons of 401(k)s
First, many plans come with high costs. The typical stock mutual fund charges 1% -- maybe a little more -- in annual fees. But many 401(k) plans are full of fund options that cost considerably more than that. And if they employ outside advisors, you might be socked with an additional fee of 2% or more. If you've got $200,000 in your account, you might be forking over $6,000 or more in fees each year!

Next, many plan participants make poor investment choices with their money, hampering their ability to grow their nest eggs. Worse yet, many 401(k) plans don't offer participants good choices to begin with. While it's true that most mutual funds don't perform as well as simple and inexpensive broad-market index funds, there are some good performers out there. Alas, you won't always find these winners in your plan's roster of available funds:

Fund

Expense Ratio

10-Year avg. Ann. Return

Holdings Include

Yacktman (YACKX)

0.95%

12.4%

Loews (NYSE: L  ) , Disney (NYSE: DIS  ) , H&R Block

T. Rowe Price Health Sciences (PRHSX)

0.86%

7.5%

Celgene (Nasdaq: CELG  ) , Express Scripts (Nasdaq: ESRX  ) , Teva Pharmaceutical (Nasdaq: TEVA  )

FPA Crescent (FPACX)

1.23%

11.2%

eBay (Nasdaq: EBAY  ) , Health Net, Ensco International (NYSE: ESV  )

Data: Morningstar.

Unfortunately, few 401(k) plans give you access to any fund you want. More often, you're stuck with what your employer gives you.

Set it and forget it? Not so fast
In addition, our 401(k) plans offer many of us a false sense of security. They could provide for all of our needs in retirement, but according to Fidelity Investments, the average account balance at the end of the third quarter of 2009 was just $60,700. If you retire with that and withdraw 4% of it yearly, as our Rule Your Retirement newsletter recommends, you'll be living on $2,428 yearly, or about $200 per month. Yikes.

Even if you retire with 10 times that, $607,000, you'll get $24,280 in your first year. That's not much, especially with many living expenses rising.

Finally, 401(k) plans leave investors at the whim of the market. You may do everything right -- saving what seems like enough, investing it effectively, and not withdrawing from your 401(k) account when you change jobs or need a loan. But if you don't invest well, a bad market can ruin all your plans. If you retired in 2007 with $1 million, but kept that nest egg in stocks, you'd have been sitting on a much smaller sum a year later.

In 401(k)s we (only sort of) trust
You still should save aggressively and investing effectively -- just remember that the market offers no guarantees. Over the long haul it will likely grow significantly, but from year to year, it's anyone's guess. If some of this doesn't seem fair, I agree with you. Congress has been considering reforms, but Fools shouldn't expect strong measures soon.

In the meantime, you can take steps to make the most of your 401(k) plan. Review your investments to make sure you're getting the highest long-term average return at the lowest annual fees. Even without any major change in the structure of 401(k)s, you can still find ways to get greater benefits out of your plan -- no matter how bad it may be.

Share your thoughts on this important matter by leaving a comment below!

Longtime Fool contributor Selena Maranjian owns shares of eBay. Walt Disney is a Motley Fool Inside Value selection. Disney and eBay are Motley Fool Stock Advisor picks. Motley Fool Options has recommended a bull call spread on eBay. Try any of our investing newsletter services free for 30 days. The Motley Fool is Fools writing for Fools.


Read/Post Comments (1) | Recommend This Article (3)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On January 28, 2010, at 1:26 PM, 401Kme wrote:

    How can you determine the true expense ratio and asset allocation of Target Date retirement "fund of funds"? Must you dig into the details of each of the underlying funds? There has to be an easier way.

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Selena Maranjian
TMFSelena

Selena Maranjian has been writing for the Fool since 1996 and covers basic investing and personal finance topics. She also prepares the Fool's syndicated newspaper column and has written or co-written a number of Fool books. For more financial and non-financial fare (as well as silly things), follow her on Twitter...

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