Fund of Funds 401(k)

Last week, I was asked by a parent at my kid’s school to review the holdings in her company retirement plan account.  Requests like this one happen frequently and I am always happy to help out.  My kids have the privilege to attend a great school and the theme there is “one big family.”

As optimistic as I always am to view a new Minnesota company’s retirement plan menu, it discourages me to continue to find the same set of circumstances.  Unfortunately, what I found was that this parent was currently 100% invested in one of the fund of funds options available on her company 401(k) retirement plan menu.

The fund of fund options is found more and more in company retirement plan menus.  This investment category on the main company retirement plan menu, along with target term funds, has grown increasingly popular.

I am sure that the company retirement plan provider has the best of intentions by making this kind of investment options available in the company retirement plan menu.  The same goes for the company retirement plan provider who is offering the latest and greatest “set-it-and-forget-it” company retirement plan gimmick.

A fund of funds invests your individual company retirement plan money in several different mutual funds on the company retirement plan menu.  The fund of funds then automatically diversifies it into a fixed allocation of these mutual funds, based on a Aggressive, Moderate or Conservative investment strategy.

Rather than taking the time and skill to pick a handful of the best mutual fund options on the company retirement plan menu, a fund of funds option does it for you.  The fund of funds option is advertised as “do-it-yourself” asset allocation investment approach.

The biggest problem with a fund of funds is that it is a very expensive way to be invested in a company retirement plan account.  The individual company retirement plan participant is paying higher than average investment management fees to each mutual fund manager in a fund of funds product.

I have seen fund of funds investment options in company retirement plan own up to 12 mutual funds in each fund.  That means that investment advisory fees are paid out to 12 different mutual fund managers—many times to own much the same individual stocks in several of the mutual funds.

In a good stock market, a few of the fund of fund options will rise in value.  In a bad stock market, almost all the fund of fund options will fall in value.  If you do make money on a couple of mutual funds, you will surely lose an equal amount on the other mutual funds.

Don’t be fooled by the fund of funds option in your company retirement plan account.  It is an expensive option that provides no more stock market risk management and potential investment performance than owning mutual funds directly.

Ric Lager
Lager & Company, Inc.