Digital advisors, also called roboadvisors, are a popular option for many people’s individual brokerage accounts. But should you let a digital advisor manage your 401(k)? The way most people invest their 401(k)s seems innocuous but in fact is a bit neglectful; here’s why turning it over to a digital platform may be the better option.
Do you have a 401(k)?
What’s a 401k, you might ask?
It’s a Defined Contribution Plan sponsored by your employer. Every month your employer will put some cash, tax free, into a retirement account that was opened for you by your employer. It’s a company perk. If your employer is a large corporation, it’s very likely that you were auto-enrolled into a 401(k) account.
Having a 401(k) means you may realize certain tax benefits. The additional cash deposits you make on the top of your employer contributions can be used as tax deductions in your annual tax returns (Federal and State) as long as you don’t go over a certain limit. Check the IRS website for the tax details.
If you do have a 401(k), this is what you should know to make sure those monthly contributions by you and your employers are managed well.
Best ways to manage your 401(k)
People tend to handle their 401(k)s in the same way. Most people “set it and forget it.” They allocate the money into a few different options that they pick based upon little, if any, diligence. Commonly these positions overlap with what they hold elsewhere in their IRAs and other accounts.
Typically people pay little attention to fees when they invest in their 401(k)s, not only the fees that they are charged by holding each mutual fund or ETF, but also the administrative fees that the 401(k) provider itself charges. They may seem insignificant but added up over time can become quite substantial. Your 401(k) isn’t free! And neither are the funds you’re invested in.
In 2011, the average total administrative and management fees on a 401(k) plan was 0.78 percent or approximately $250 per participant (source: Wikipedia). Remember that you are paying for the “service” provided by the 401(k) program as well as the company managing the mutual funds and ETFs within your portfolio.
The other aspect of investing that people tend to neglect when investing their 401(k)s is the idea of holding a complete and diversified asset allocation. The options offered by most 401(k) plans allow you to build a portfolio of basic risk profiles (conservative, agressive, neutral) with basic types of investments – domestic stock, bonds, international stock, and maybe a commodity fund here or there. However that’s where the variety ends. The range of options is very limited, and does not include a full range of subclasses of investments that might be better performing. This potentially compromises your ability to achieve total and complete diversification.
Your company is not an investment manager
There is the idea that because a fund is on the company’s platform it has been checked out and is worthy of being invested in. There’s also the notion that this fund is better than other similar ones that aren’t on the platform.
In reality this is far from the truth – in fact it’s a pretty clear departure from reality in most cases.
In the past, plan sponsors in some instances were paid to offer funds on the platform. By law, your plan sponsor is required to act in a fiduciary capacity and provider adequate options, or to appoint a capable fiduciary (often a third party consultant) to do so if they are unable to themselves.
However most companies don’t do a great job at this. Because they don’t have to. The plan sponsor’s objective is to fulfill their obligation – and nothing more. Optimizing your investment results is not their objective.
Think for a second about how your company makes money. It is simply not in the business of great portfolio construction and portfolio management. They don’t make a dime more of profit by having a great 401(k) plan.
As a result, the process of selecting funds for a 401(k) plan isn’t the most well thought out one in the world. Often the choice of funds comes down to a popularity contest where one consulting company designs a lineup of funds that they uniformly recommend to all plan sponsors. As a result you see the same Mutual Funds and ETFs offered on several company’s 401(k) plans. The company’s own company stock (in the case you work for a Forbes 500 firm) might be included as options. As long as the options meet certain regulatory criteria, the plan sponsor has done its job. But the question remains – are these funds really the best ones available out of the whole universe? Often the answer is no.
Should you use a roboadvisor to rescue your 401(k) plan?
So given all of this, where does it leave you as you face this decision. Is it better to use a roboadvisor to invest your 401(k) plan?
- A better identification of your risk tolerance
- 401(k) are static by default, make your 401(k) dynamic with a RoboAdvisor
- Find better investment options with a RoboAdvisor
- Increase your risk diversification and portfolio performance
- Make your Roboadvisor a super manager with 401(k)/IRA Rollovers
Don’t invest a dime of your money until you come up with a solid assessment of how much risk you can take. You absolutely should determine this beforehand by using a questionnaire or some other thorough method of quantifying your risk tolerance.
Risk is all encompassing and includes all money invested in your portfolio. Risk is taken with the money you invest in your 401(k) and elsewhere in IRAs, etc. Don’t think that just because the money is held in a 401(k), it’s safer.
You should be looking at your total portfolio in its entirety, not just one account at a time. Be aware of funds redundancy.
Your robo-advisor should construct a portfolio based on your risk expectations and be sophisticated enough to build a portfolio that is more complex than the simple Conservative, Aggressive, Neutral portfolio models of most 401(k) sponsors.
If you are using a static approach by default, you don’t actively manage your funds, and you lose the opportunity to benefit from market fluctuations. Isn’t that why you invested your money in the first place? There’s a lot of money to be lost by not being aware when the market dips.
Pay attention to which mutual funds, ETFs, or stocks are best. There are a variety of qualitative and quantitative factors to look at to determine this and the evaluation process is ongoing. The most popular options aren’t necessarily the best ones. But a robo-advisor can find you the best investment options to fit your risk profile, while optimizing on the funds cost and price variability, so you can buy them at the right price. Most 401(k) platforms will not bother with this, and will buy investment funds at whatever price they find convenient, no matter how expensive it might be.
Find an investment lineup that includes the nitty gritty, the asset subclasses that most 401(k)s don’t offer, so your 401(k) can benefit from potentially better performing funds. These also can often provide an opportunity for greater diversification by exposing you to new and different areas of the market that the traditional options do not.
Do you have 401(k)s at old employers? Who is managing them? If your new 401(k) is being managed by a roboadvisor, you can do a direct rollover of your old 401(k)s into your new 401(k) plan and optimize both costs and performance options.
Even if your new employer doesn’t offer a 401(k) plan or your new 401(k) plan can’t be managed by a third party like a roboadvisor, you can always open an IRA account with a roboadvisor and rollover your 401(k)s, under the IRS defined timing conditions, into your new IRA account. Rollovers into IRAs will give you more control of both costs and asset allocation. Note that if you have a Roth 401(k), you can only do a rollover to a Roth IRA. Here are some resources to find out more about 401(k) rollovers.
Summary of your options to have your Roboadvisor manage your 401(k)
401(k)s, whether offered by your employer or set up as a self-employed option if you own your company, are a great way to stash away a ton of cash with attractive tax benefits. If you’re looking to pursue some of the great digital investing options available to you and put your 401(k) to work with a roboadvisor, consider WealthVenue. Ready to give us a try? Sign up here and we will run your 401(k).