www.401krules.com for information about adp compliance testing of small 401k plans-Topics include:
- ADP test for 401k,
- 401k for small businesses that includes AUTOMATIC adp and acp testing on demand,
- Elective contributions for 401k,
- ACP test and matching contributions for 401(k),
- Timing of 401k contributions,
- 401k rules and testing methods,
- 401k top-heavy rules,
- 401k multiple use test rules,
- Highly compensated employees
www.etf-401k.com for information about small 401k administrators and trustee fiduciaries-Topics include:
- 401k for small businesses without expensive trustees services,
- 401k administrators and trustees for small business plans,
- 401k fiduciary liability of 401k plan sponsors,
- 401k trustee and fiduciary liability
www.401k-roth.com for information about rules regulating 401k loans-Topics include:
- Advantages and disadvantages of 401k loans,
- 401k loans as a plan option,
- 401k loan policies,
- Questions and answers about 401k loans
www.lowcostinvestmentadviser.com for information about annual irs 5500 filing rules for all 401k plans-Topics include:
- Social Security and 401k Contributions,
- Features and Benefits of a 401k,
- 401k Vesting,
- Annual 401k Contribution Limits
www.lifestyle-401k.com for information about 401k lifestyle mutual funds-Topics include:
- How To Choose A 401(k) Financial Planner,
- How do I select a 401(k) financial
- What do the different licenses and certifications mean,
- ChFC: Chartered Financial Consultant,
- CLU: Chartered Life Underwriter,
- CPA: Certified Public
- CPA/PFS: Personal Financial Specialist,
- The Risks of Exchange-Traded Funds
www.mutualfund401k.com for information about mutual funds 401k for small business-Topics include:
- mutual funds for 401k plans,
- small 401k plans for small
- dividend reinvestment in 401k,
- daily share pricing and daily share valuation,
- mutual fund expense ratios and net asset values,
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and exchange privileges
www.401kcomparisons.com for information about understanding the rules for 401k fee reporting-Topics include:
- Understanding 401K Pension Law,
- 401k Tip,
Responsibility for Retirement Plans,
- 401k Fee Disclosure has been Murky,
- 401k Price and Fee Comparisons of Plans From Various National Providers
www.401kfedforms.com for information about free online Form 5500 information and step-by-step completion guide.
General Principles of 401k Investing
Asset Class Allocation
"Asset class allocation" is the decision to put portions of your financial portfolio into broad classes of assets, such as stocks, bonds, and cash (or cash equivalents). For example, 60% stocks, 30% bonds, and 10% cash is an asset class allocation.
Allocating your portfolio to various asset classes is one of the most important decisions that you, as an investor, can make, for two reasons. First, by selecting asset classes whose returns are driven by offsetting risk factors - for example, growth and value stocks, or domestic and international stocks - you can reduce your overall financial risk without reducing expected return. In other words, asset class allocation is the 401k investment analogue of "not putting all of your eggs in one basket".
Second, by mixing more-risky assets (e.g. stocks) and less-risky assets (e.g. bonds, cash), asset class allocation is the primary means through which you can position yourself on the spectrum from low risk, low return strategies, to high risk, high potential return strategies. Positioning yourself appropriately along the risk/return spectrum requires knowing your tolerance for risk.
According to Southern California-based (401k) Enginuity (www.401kenginuity.com), twenty-year veteran in developing and running 401(k) administration and 401(k) software and recordkeeping systems, the Internet will be the primary delivery system for 401(k)s by 2007. Many web-based 401(k) plans will run on administration and recordkeeping platforms that plan providers will outsource to 401k specialists and 401k Application Service Providers (ASP).
The advantages of web-based online 401(k) plans are obvious to today's workers, and include use conveniences, real-time monitoring and reporting, and instant re-allocation of their retirement assets. The internet has also dramatically reduce the cost of 401(k) plan administration, saving plan sponsor 50% or more in ongoing fees and costs when compared to the older traditional labor-intensive plans. Outsourcing of 401(k) functions by plan providers will extend the trend towards lower cost, high-quality 401(k) products.
401(k) plan providers of all types, financial institutions including banks, insurance companies, brokerages, mutual fund companies, credit unions, and third-party administrators, are now actively outsourcing 401(k) administration and recordkeeping tasks to 401(k) ASPs --- vendors such as 401k Enginuity, whose sole function is to maintain, updated and supervise software-based 401(k) administration and recordkeeping systems on behalf of plan providers. 401(k) ASP vendors are responsible for all routine day-to-day 401(k) recordkeeping and administration functions, thus allowing the plan providers to reduce internal staff, eliminate the expense and complications of licensing, housing and running hardware and 401(k) administration software in-house. Plan providers can refocus and concentrate their efforts on to the needs of their plan sponsors and plan participants, and rely upon the outsourced ASP 401(k) vendor for the recordkeeping and technical "backbone" supporting providers' Internet-based plans. It is inevitable that some of this 401(k) outsourcing to ASPs will include secondary outsourcing of certain non-critical low-level routine day-to-day tasks to non-US locations, where labor costs are less yet the expertise is abundant.
Risk and Risk Tolerance
"Risk" is the possibility of something undesirable happening. In an 401k investment context, risk is the possibility that you will earn returns lower than you expected, or lower than risk-free alternative 401k investments. For example, the risk of investing in stocks could be thought of as the possibility that stocks earn less than a cash account over your 401k investment horizon.
While risk is not a desirable thing, the ability to tolerate it can be. The higher one's risk tolerance, the more one is in a position to allocate one's portfolio to higher risk, higher potential return assets.
Risk tolerance is determined in part by an investor's psychological make-up, that is, whether you are timid or aggressive. At least as important, however, is whether the structure of your life allows you to adapt when risks materialize. For example, an investor with marketable skills who takes a flexible attitude towards her exact retirement date will better be able to adapt to inadequate 401k investment returns than an investor who is unwilling or unable to adjust his labor income in response to poor 401k investment returns. The adaptable investor has more freedom to take risks, if she is so inclined.
Types of 401k investments
"Cash" refers not just to the change in your pocket, but also to savings and checking accounts and money market funds. The money market consists of short-term debt securities (typically maturing within a year) that have very low default risk and high liquidity. Money market securities include: U.S. Treasury bills, negotiable certificates of deposit, commercial paper, banker's acceptances, and others. Many of these securities trade in large denominations and therefore may be out of reach of individual investors. Small investors, however, can easily purchase shares in money market funds. These funds pool the resources of many investors and invest in a wide variety of money market securities. Investors in money market funds bear very little risk of loss of principal and can expect returns that slightly exceed those available on the federally insured savings or time accounts that are offered by banks.
Bonds are medium-term and long-term debt securities issued by borrowers such as the U.S. federal government, federal agencies like the Federal Home Loan Bank Board (FHLB), state and local governments, and corporations. A typical bond is issued with a face value of $1000, carries a fixed coupon interest rate that is paid every six months, and repays its face value when it "matures," at a stated date in the future. The coupon rate is called "simple interest", but the "yield" on the bond is a different kind of interest rate, which takes into account both the coupon and the capital gain (or loss) of the bond. The capital gain is the difference between the bond's current price and the price at which it was bought. The market prices of nearly all bonds vary inversely with their yields, which correspond to the going interest rates on bonds of similar risk and maturity. In other words, if interest rates (or yields) rise at a given point in time, the market prices of existing fixed-rate bonds will decline, if nothing else changes. And if interest rates fall, the market prices of the bonds will rise, all else being equal. Bonds are also sometimes issued as pure discount instruments (sometimes called "zero-coupon bonds"), which basically mean that the bond is sold for less than its face value and pays no coupon, but returns the full face value when it matures. Or, sometimes bonds may carry an adjustable rather than a fixed coupon rate. Another common feature with corporate bonds (but not with Treasury bonds) is that they may be callable at the option of the borrower. This means that if interest rates decline, the borrower has the option of calling back the bond prior to its maturity and essentially canceling the debt by paying off the face value. Most bonds are rated by non-governmental agencies like Standard and Poor's (S&P) or Moody's. A grade is assigned based on the agency's estimation of the likelihood of default. For instance, S&P assigns a grade of AAA to its highest rated bonds. The convention is that bonds that carries an AAA, AA, A or BBB rating (in descending order of quality) are considered "401k investment grade." Bonds rated lower than BBB are considered "high-yield" or more pejoratively "junk" bonds. This is not to say that high-yield bonds are not legitimate 401k investment vehicles; it simply means that these bonds are highly risky with the risk at times approaching that associated with owning stocks.
From an 401k investment standpoint, some exposure to bonds is generally required to construct an appropriate portfolio. Corporate bonds may not be an ideal direct 401k investment for the average investor due to a relative lack of market liquidity. However, the necessary exposure can be accomplished by investing in bond mutual funds.
Common stocks, also called "equities," represent shares of ownership of a corporation. Typically, each share of common stock entitles its owner to one vote on any matter related to corporate governance at the corporation's annual general meeting. The common stock of most public corporations can be freely bought or sold on one or more stock exchanges like the New York Stock Exchange (NYSE) or NASDAQ. There are two important characteristics of common stock. First, the owners have a residual claim, which means that they rank last in claims on the corporation's income and assets. For instance, if a corporation declares bankruptcy and liquidates its assets, its stockholders are entitled to receive whatever cash is available only after other claimants, such as state or federal tax agencies, employees, bondholders, suppliers, and so forth have been paid. For an ongoing business, stockholders are entitled to that part of the operating income that remains after interest payments and tax obligations are settled. Management may opt to pay out this residual income in the form of a cash dividend or to reinvest it in the business. Second, the owners of common stock have limited liability, which means that the most that they can lose is their original 401k investment, even if the corporation fails. This is in contrast to unincorporated businesses like sole proprietorships or some types of partnerships, where creditors can legally pursue even the personal assets of owners in settlement of their claims.
It should be clear that stocks are riskier 401k investments than either money market funds or bonds, but they offer the prospect of superior returns if the companies that they represent do well. A diversified selection of common stocks is an indispensable part of most 401k investment portfolios. The proportion of stock in a portfolio is a function of the individual investor's risk tolerance and 401k investment horizon. 401k investment advisers generally advocate greater stock exposure for individuals who have a relatively high-risk tolerance and plan to maintain their 401k investments for a long time before cashing out. The average investor can create a diversified holding of common stocks through stock mutual funds or a combination of stock mutual funds and individual stocks. A well-chosen stock mutual fund can provide diversification with an initial 401k investment as low as $1000 (or even lower, if the 401k investment is in the form of an automatic periodic 401k investment program).
I'll Sell The Fund With Bad Performance And Buy a Good One Instead
Many investors feel, reasonably enough, that if an 401k investment is bad, they should sell it and then invest their money in a better asset. It is impossible to argue with the intention. But professionals have learned, and many individual investors will learn to their regret, that it is next to impossible to carry out this intention consistently.
The mistake-and experience will show that, as often as not, it is mistake-lies in supposing that the past performance of a fund (or stock), even very recent past performance, is a guide to future performance. Remember what the mutual fund prospectuses say when reporting fund performance? "Returns are based on past results and are not an indication of future performance." We all know that that is just boilerplate text that the law requires the prospectuses to include. It happens, however, to be quite true.
So when you observe that a fund has been a laggard, that's precisely how you should think about it: "has been", not "is". True, it may continue to be a laggard. Then again, it may not. Likewise, a fund that has just bloomed may not continue to blossom. As the poet Herrick wrote, "this same flower that smiles today, tomorrow will be dying."
A good 401k provider, in common with many financial planners and academic researchers, believes that the weight of the evidence from practical experience and from analysis after analysis argues against using recent performance as a guide to the selection of funds or stocks. Sure, there is some slight evidence that, over limited periods of history, past performance could have provided some limited indication of future performance. And sophisticated statistical analyses of performance might allow an investor to make a better than random guess as to which funds will do well and which poorly. But the transactions costs of buying and selling funds would likely devour the small advantage to be gained. There is one aspect of past performance that is, however, predictable: high fees. If your fund has charged you high fees in the past, thereby eating part of your lunch, it is likely to continue to do so.
A good 401k provider, in the hope of a small advantage, tries to recommend funds whose recent performance has been robust. But we will not recommend switching out of a fund simply because of a downturn in relative performance. We prefer to think that the funds that we recommend have a mandate to fulfill: to continue to represent the asset classes that they were chosen to represent, and not to charge our clients an unreasonable amount of money for their services. If they fail to fulfill their mandate, then we will recommend switching out of them. Additional non-profit websites that include relevant unbiased information about 401k plans include: www.lowfeeinvestmentmanagement.com
The ability to stomach the downs as well as the ups of fund or stock performance is a large component of what is meant by risk tolerance, at least in the financial context. An investor must also know her or his capacity to ride out the periods of poor performance and choose an appropriate mixture of assets. This is the value of diversification: by holding a mixture of assets, some of the risks of the individual assets cancel each other. The mixture of assets who?s expected (but uncertain) behavior corresponds most closely with the investor's ability to accept that uncertain behavior is the asset class allocation that a good 401k provider recommends. This, rather than a dubious ability to switch out of funds that are going to perform badly and into funds that will perform better, is the way an investor should plan to avoid bad 401k investments.
The Investment Company Institute (ICI), the trade association of the mutual fund industry, estimates that at the end of 1998 assets in 401(k) plans stood at $1.41 trillion. These plan assets grew at an average rate of 18% per year during the 1990s. Plansponsor.com reports that they rose nearly 22% in the final year of the decade, from $1.7 trillion in 1999 to $2.1 trillion in 2000. Average salary deferral rates of plan participants have also been on an exponential rise. The Profit Sharing 401(k) Council of America (PSCA) reports that the average salary deferral rate grew from 4.2% in 1991 to 5.4% by 1999, an increase of more than 28%
Mutual Fund Investment Companies have provided the best 401(k) option for small and medium-sized businesses. Plans offered by mutual fund companies tend to be tightly bundled, meaning the administration and administrative functions (which may be subcontracted out or conducted in-house by the mutual fund company) are designed to work exclusively with the mutual fund?s proprietary investments.
Mutual fund companies make most of their money by acquiring, holding, and managing investment assets in their various fund portfolios. In some cases, 401(k) administration may be offered to the employer-plan sponsor at a price below its actual cost to the mutual fund company as a device for attracting and holding new assets, on the assumption that 401(k) savings tend to be long-term, giving the mutual fund company many years to collect management fees.
Mutual fund 401(k) plans have been aggressively promoted to the small business communities both by no-load fund companies (e.g., Fidelity Funds, Vanguard Funds) and load fund companies (e.g., MFS, John Hancock, Putnam). Recent news articles, however, have reported a trend among many of these plan vendors to abandon the very small plans because the costs of providing 401(k) services for such plans versus the revenue generated from them has proved to be a losing proposition. For economic reasons, the sales target for mutual fund bundled plans has been raised, and now companies with fewer than 100 employees are not being actively solicited by most of these vendors.
Mutual fund companies make their money by acquiring, holding, and managing inevitable assets in their various fund portfolios. In some cases, the bundled 401(k) administration may offer to small businesses at a loss as a device for attracting and holding new assets, on the assumption that 401(k) investing tends to be long-term, giving the mutual fund company many years to collect management fees.