A World-Class Menu of 401(k) Choices
By Paul Merriman Last Update: 1:35 AM ET Jan. 16, 2002

SEATTLE (CBS.MW) -- Limited choices among company retirement plans are a national scandal but savvy employees have been successful at petitioning their plans to offer greater variety and I urge you to do the same. 

Last week, I blasted 401(k) plans for not giving investors enough choices to make their retirement savings do the most for them. Readers responded strongly, asking for solid mutual funds that would better their diversification efforts. 

To give investors the optimum menu of choices, 401(k) plans must include mutual funds that specialize in six asset classes:

U.S. large-company growth stocks, U.S. large-company value stocks, U.S. small-company growth stocks, U.S. small-company value stocks, international large-company stocks and international small-company stocks. 

Since most 401(k) plans provide adequate choices among bond funds, we've chosen to focus only on stock funds.

Virtually all 401(k) plans offer funds that invest in popular U.S. large-company growth stocks. See related story. 

But the other five asset classes often are neglected. Why does that matter? 

Over the past 30 years, each of the other five asset classes has had higher performance than large-company growth stocks. When you combine all these asset classes, you get higher returns at less risk. 

There's no way to know in advance which asset class will perform best in any given time, so we advise our clients to invest equal percentages in all the important classes. 

The best way a mutual fund can capture the returns of an asset class is to keep expenses and portfolio turnover as low as possible while investing as broadly as possible. 

That's a prescription for index funds, and we think they're the best choices for long-term investors. 

Dimensional Fund Advisors 

If we could choose only one family of funds for the ideal 401(k) plan, it would be Dimensional Fund Advisors. We believe DFA's institutional index funds are the best, and employees whose plans include them are fortunate. DFA is the only no-load fund family with index funds that cover each asset class that we recommend. 

Although DFA funds are available to the public only through investment advisors, a small but growing number of 401(k) plans include them as options. 

In 2001, a portfolio of DFA funds weighted equally among the asset classes we listed above would have appreciated by 1 percent. Doesn't seem like much but it's much better than the 12 percent loss in the Standard & Poor's 500 Index and the 23 percent decline by the average large-company growth fund. 

The only fund family that even comes close to DFA's ability to offer index funds in every important asset class is Vanguard.

The Vanguard Group 

Fortunately, Vanguard funds are available in many 401(k) plans. Employees who have access to all Vanguard funds could set up a nearly ideal portfolio using equal percentages of these six funds: Vanguard 500 Index, Vanguard Value Index, Vanguard Small-Cap Index, Vanguard Small-Cap Value Index, Vanguard Total International Stock Index and Vanguard International Value. 

Vanguard's international offerings don't include a small-company fund, a noteworthy drawback. In this portfolio, we've substituted International Value, which gives investors a slightly different kind of advantage among international stocks. 

In 2001, this Vanguard portfolio would have lost 6.9 percent.

Fidelity Investments 

Many 401(k) plans include Fidelity funds, and employees can put together a diversified portfolio using equal investments in five of them: Fidelity Spartan 500 Index, Fidelity Equity Income, Fidelity Small Cap Stock, Fidelity Low Priced Stock and Fidelity Spartan International Index. 

Fidelity has neither an international value nor an international small-company fund, so this portfolio gives less-than-ideal diversification. 

In 2001, that Fidelity portfolio would have fallen by 1.2 percent. 

Breaking away from the family 

Finally, many 401(k) plans are administered through Charles Schwab & Co., which offers a large selection of actively managed funds from many families.

We've put together our first choices for funds that are available on a no-transaction-fee basis from Schwab; while these funds don't have the low expenses of index funds, they have top-notch management and focus on the important asset classes. 

Our picks at Schwab are Schwab 1000 Index (large-company growth), Dodge & Cox Stock (large-company value), Fremont U.S. Microcap (small-company growth), Third Avenue Small Cap Value (small-company value), Artisan International (international growth) and Tweedy, Browne Global Value (international value). 

Like the Vanguard portfolio, this mix of funds substitutes international value in place of an international small-company fund. 

In 2001, a portfolio equally weighted in those six funds would have lost 0.5 percent. 

Funds like these are the most effective tools employers can give their employees to maximize retirement savings. 

If your 401(k) doesn't have good choices in the asset classes that we recommend, show the trustees of your plan this article and lobby for better options for a better future. 

It's in the trustees' own interests to grant your request, because they are most likely invested in your 401(k) plan themselves. 

Paul Merriman is founder of Merriman Capital Management in Seattle and is editor and publisher of FundAdvice.com.

 
  

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