Why are typical 401(k) plan fund choices so awful?
401k choices are awful because: The best remedy I have found is to roll over to an IRA when changing jobs. I would point this out to the committee or other entity in charge of handling this at work. They do have a fiduciary responsibility for the participant's money and should take anything reasonable seriously. The flip side to this is 95% of participants -- especially participants under 35 or so -- really pay next to no attention to this stuff. We consider it a victory to get people to pony up the matching contributions. Active participation in investment would blow our minds. The managers of the 401(k) have to make their money somewhere.  Either they'll make it from the employer, or from the employees via the expense ratio.  If it's the employer setting up the plan, I can bet whose interest he'll be looking after. Regarding your last comment, I'd recommend looking outside your 401(k) for investing.  If you get free money from your employer for contributing to your 401(k), that's a plus, but I wouldn't -- actually, I don't -- contribute anything beyond the match.  I pay my taxes and I'm done with it. To piggy back mbhunter's answer, the broker is going to find a way to make the amount of money they want, and either the employee or the company will foot that bill. But additionally, most small businesses want to compete and the market and offer benefits in the US.  So they shop around, and maybe the boss doesn't have the best knowledge about effective investing, so they end up taking the offering from the broker who sells it the best. Give you company credit for offering something, but know they are as affected by a good salesperson as anybody else.  Being a good sales person doesn't mean you are selling a good product.
401K accounts, both regular and Roth, generally have loans available. There are maximum amounts that are based on federal limits, and your balance in the program. These rules also determine the amount of time you have to repay the loan, and what happens if you quit or are fired while the loan is outstanding. In these loan programs the loan comes from your 401K funds. Regarding matching funds. This plan is not atypical. Some match right away, some make you wait. Some put in X percent regardless of what you contribute. Some make you opt out, others make you opt in. Some will direct their automatic amounts to a specific fund, unless you tell them otherwise.  The big plus for the fund you describe is the immediate vesting. Some companies will match your investments but then only partially vest the funds. They don't want to put a bunch of matching funds into your account, and then have you leave.  So they say that if you leave before 5 years is up, they will not let you keep all the funds. If you leave after 2 years you keep 25%, if you leave after 3 years you keep 50%... The fact they immediately vest is a very generous plan. This is literally the worst article ever.  First dividends are not guaranteed, and the higher the yield the higher the risk for a dividend paying stock. When buying a stock that pays dividends make sure they have the cash flows to cover it long term.  Utility stocks are interest rate sensitive. If we head into a period of high interest rates, utility stocks are going to underperform, if not get killed.  Exchange traded funds can be extremely risky, and some have much higher fees than mutual funds.  Variable Annuities should never be purchased unless you have exhausted all other tax deferred strategies, and then probably still to be avoided because of high fees.  Money markets and CDs aren't really investments. They're a cash alternatives that May not keep up with inflation. An index fund is inherently diversified across its index -- no one stock will either make or break the results. In that case it's a matter of picking the index(es) you want to put the money into. ETFs do permit smaller initial purchases, which would let you do a reasonable mix of sectors. (That seems to be the one advantage of ETFs over traditional funds...?) "Unfortunately, I missed most of segment and I didn't get to understand the Why? To begin with, Cramer is an entertainer and his business is pushing stocks. If you put money into mutual funds (which most 401k plans limit your investments to), then you are not purchasing his product. Also, many 401k plans have limited selections of funds, and many of those funds are not good performers. While his stock-picking track record is much better than mine, his isn't that great.  He does point out that there are a lot of fees (mostly hidden) in 401k accounts. If you read your company's 5500 filing (especialy Schedule A), you can determine just how much your plan administrators are paying themselves. If paying excessive fees is your concern, then you should be rolling over your 401k into your IRA when you quit (or the employer-match vests, which ever is later).  Finally, Cramer thinks that most of his audience will max out their IRA contributions and have only a little bit left for their 401k. I'm most definately ""not most people"" as I'm maxing out both my 401k and IRA contributions." While the other answers are good, I wanted to expand a little on why I feel a ROTH is a bad way to go unless you are young. First, let's pretend you have a 25% tax rate. And your investments will go up 5% per year for 10 years. You contribute 6% of income for one year. You can do a traditional or a roth 401k/IRA. Here's the math: Traditional: 6% of income invested. Grows at 5% for 10 years. Taxed at 25% on withdrawl. = (Income * 6%) * (1.05 ^ 10) * (100% - 25%) = (Income * 6%) * 1.63 * .75 = 7.33% of your original income - but this is after taxes ROTH: Taxes taken out of income. Then 6% of that goes into the fund(s). Still grows at 5% for 10 years. Not taxed at withdrawl. = (Income * (100% - 25%) * 6%) * (1.05 ^ 10) = (Income * 75% * 6%) * 1.63 = 7.33% of your original income - again this is after taxes. Look familiar? They are the same. It's the simple transitive property of mathematics. So why do a traditional vs. a ROTH? The reason is that your tax bracket changes. This changes because your income changes. Say when you retire you plan to have your home or vehicle paid for. You expect to be able to live on $50,000 per year. This means when you make MORE than $50,000 you should do a traditional plan and when you make less than this you should do a ROTH plan. Example: You make $100,000 and your upper bracket is now 30%. You save 30% by doing a traditional and then pay back 10, 20, and 30% as you withdraw a salary of $50,000. Traditional = better. Example: You make $30,000 annually. Your upper bracket is 20%. You pay 20% on a roth. Then you withdraw funds to get to $50,000 anually and never pay the higher bracket. Roth = better. ROTH advocates typically bring up tax rates. Of course they will go up they insist. So you always should do a ROTH. Not so fast. Taxes have gone down in recent years (No one please start a political debate with me. Some went up, some went down, but overall, federal income rates dropped). Even if taxes rose 5%, a traditional will still be better than a ROTH in many cases. "The ""Money 70"" is a fine list: http://money.cnn.com/magazines/moneymag/bestfunds/index.html Money magazine is usually more reasonable than the other ones (SmartMoney, Kiplinger's, etc. are in my opinion sillier). If you want a lot of depth, the Morningstar Analyst Picks are useful but you have to pay for a membership which is probably not worth it for now: http://www.morningstar.com/Cover/Funds.aspx (side note: Morningstar star ratings are not useful, I'd ignore those. analyst picks are pretty useful.) Vanguard is a can't-go-too-wrong suggestion. They don't have any house funds that are ""bad,"" while for example Fidelity has some good ones mixed with a bunch that aren't so much. Of course, some funds at Vanguard may be inappropriate for your situation. (Vanguard also sells third-party funds, I'm talking about their own branded funds.) If getting started with 5K I think you'd want to go with an all-in-one fund like a target date retirement fund or a balanced fund. Such a fund also handles rebalancing for you. There's a Vanguard target date fund and balanced fund (Wellington) in the Money 70 list. fwiw, I think it's more important to ask how much risk you need to take, rather than how much you are willing to take. I wrote this down at more length here: http://blog.ometer.com/2010/11/10/take-risks-in-life-for-savings-choose-a-balanced-fund/ First pick your desired asset allocation, then pick your fund after that to match. Good luck." "Having worked for a financial company for years, my advice is to stay away from all the ""Freedom Funds"" offered.  They're a new way for Fidelity to justify charging a higher management fee on those particular funds.  That extra 1% or so a year is great for making the company money; it will kill your rate of return over the next 25+ years you're putting money into your retirement account.  All these funds do is change the percentage of your funds in stocks vs. more fixed investments (bonds, etc.) so you have a higher percentage in stocks while you're young and slowly move the percentage more towards fixed as you get older.  If you take a few hours every 5 years to re-balance your portfolio and just slowly shift more money towards fixed investments, you'll achieve the same thing WITHOUT the extra annual fee. So how much difference are we talking here?  Let's do a quick example.  Based on your salary of $70k and a 4% match by your company, you'll have $5,600 a year to put in your 401(k) (your 4% plus matched 4%).  I'll also assume an 8% annual return for both funds.  Here is what that 1% extra service charge will cost you: Fund with a 1% service charge: Annual Fee Paid Year 1 - $60.00 Annual Fee Paid Year 25 (assuming 8% growth in assets) - $301.00 Total Fees Year 1 through 25:  $3,782 Fund with a 2% service charge: Annual Fee Paid Year 1 - $121.00 Annual Fee Paid Year 25 (assuming 8% growth in assets) - $472.00 Total Fees Year 1 through 25:  $6,489 That's a total of $2,707 in extra fees over 25 years on just the investment you make this year!  Next year if you invest the same amount in your 401k that will be another $2,707 paid over 25 years to the management company.  This pattern repeats EACH year you pay the higher management fee.  Trust me, if you invest that money in stock instead of paying it as fees, you'll have a whole lot more money saved when it's time to retire. My advice, pick a percentage you're comfortable with in stocks at your age, maybe 85 - 90%, and pick the stock funds with the lowest management fees (the remaining 10 - 15% should go into a fixed fund).  Make sure you pick at least some of your stock money, I do 20 - 25%, and select a diverse (lots of different countries) international fund. For any retirement money you plan to save above the 4% getting matched by your company, set up a Roth IRA.  That will give you the freedom to invest in any stocks or funds you want.  Find some low-cost index funds (such as VTI for stocks, and BND for bonds) and put your money in those.  Invest the same amount every month, automatically, and your cost average will work itself out through up markets and down. Good luck!" "All right, I will try to take this nice and slow. This is going to be a little long; try to bear with me. Suppose you contribute $100 to your newly opened 401(k). You now have $100 in cash and $0 in mutual funds in your 401(k) (and $100 less than you used to somewhere else). At some later date, you use that money within the 401(k) to buy a single share of the Acme World All-Market Index Fund which happens to trade at exactly $100 per share on the day your purchase goes through. As a result, you have $0 in cash and exactly one share of that fund (corresponding to $100) within your 401(k). Some time later, the price of the fund is up 10%, so your share is now worth $110. Since you haven't contributed anything more to your 401(k) for whatever reason, your cash holding is still $0. Because your holding is really denominated in shares of this mutual fund, of which you still have exactly one, the cash equivalent of your holding is now $110. Now, you can basically do one of two things: By selling the share, you protect against it falling in price, thus in a sense ""locking in"" your gain. But where do you put the money instead? You obviously can't put the money in anything else that might fall in price; doing so would mean that you could lose a portion of your gains. The only way to truly ""lock in"" a gain is to remove the money from your investment portfolio altogether. Roughly speaking, that means withdrawing the money and spending it. (And then you have to consider if the value of what you spent the money on can fluctuate, and as a consequence, fall. What's the value of that three weeks old jug of milk in the back of your refrigerator?) The beauty of compounding is that it doesn't care when you bought an investment. Let's say that you kept the original fund, which was at $110. Now, since that day, it is up another 5%. Since we are looking at the change of price of the fund over some period of time, that's 5% of $110, not 5% of the $100 you bought at (which was an arbitrary point, anyway). 5% of $110 is $5.50, which means that the value of your holding is now at $115.50 from a gain first of 10% followed by another 5%. If at the same day when the original fund was at $110 you buy another $100 worth of it, the additional 5% gain is realized on the sum of the two at the time of the purchase, or $210. Thus after the additional 5% gain, you would have not $210 (($100 + $100) + 5%), nor $205 (($100 + 5%) + $100), but $220.50 (($110 + $100) + 5%). See how you don't need to do anything in particular to realize the beauty of compounding growth? There is one exception to the above. Some investments pay out dividends, interest or equivalent in cash equivalents. (Basically, deposit money into an account of yours somewhere; in the case of retirement plans, usually within the same container where you are holding the investment. These dividends are generally not counted against your contribution limits, but check the relevant legal texts if you want to be absolutely certain.) This is somewhat uncommon in mutual funds, but very common in other investments such as stocks or bonds that you purchase directly (which you really should not do if you are just starting out and/or feel the need to ask this type of question). In that case, you need to place a purchase order yourself for whatever you want to invest the dividend in. If you don't, then the extra money of the dividend will not be growing along with your original investment." Let me throw in one more variable to consider. Company 401K plans typically have MUCH higher fees than you are likely to get if you shop around on your own as long as you don't go with a high dollar broker. You won't see these fees on your statements typically, which I think is criminal, but they are hidden in the prices of the funds you are buying in the 401K.  If you don't believe me, get the quotes for a fund from the 401K company's web-site then look up the same fund on a site like MSMoney. The share prices won't match and you will be angry until you come to terms with it. So if you have a choice of money in a personal retirement account versus a 401K always go with your own account... UNLESS:   or "Your question has a built in faulty premise.  ""ASSUMING a person knows how to use and invest their money wisely"" I'd ask if you were wise enough to beat the investments offered in your 401(k) after expenses, and with respect to the potential tax savings.  Then, since I'm a proponent of ""deposit to the match, even if you have to eat rice and beans to find the cash to do"" I'll extend the question to ask if you can beat the choices taking the match into account.  401(k) - Your $1000 starts as $1500 and has a tax due on withdrawal years later. AeroAccount - You start with $750 (after the tax) and might spend a decade before hitting $1500.  Start your own company? That might be another story. But to invest in the market and still beat the matched 401(k) takes a bit more wisdom than I'd claim to have." Mostly you nailed it.  It's a good question, and the points you raise are excellent and comprise good analysis. Probably the biggest drawback is if you don't agree with the asset allocation strategy.  It may be too much/too little into stocks/bonds/international/cash.   I am kind of in this boat.  My 401K offers very little choices in funds, but offers Vanguard target funds.  These tend to be a bit too conservative for my taste, so I actually put money in the 2060 target fund.  If I live that long, I will be 94 in 2060.   So if the target funds are a bit too aggressive for you, move down in years.  If they are a bit too conservative, move up. "I don't think you have your head in the right space - you seem to be thinking of these lifecycle funds like they're an annuity or a pension, but they're not. They're an investment. Specifically, they're a mutual fund that will invest in a collection of other mutual funds, which in turn invest in stock and bonds. Stocks go up, and stocks go down. Bonds go up, and bonds go down. How much you'll have in this fund next year is unknowable, much less 32 years from now. What you can know, is that saving regularly over the next 32 years and investing it in a reasonable, and diversified way in a tax sheltered account like that Roth will mean you have a nice chunk of change sitting there when you retire. The lifecycle funds exist to help you with that ""reasonable"" and ""diversified"" bit.They're meant to be one stop shopping for a retirement portfolio. They put your money into a diversified portfolio, then ""age"" the portfolio allocations over time to make it go from a high risk, (potentially) high reward allocation now to a lower risk, lower reward portfolio as you approach retirement. The idea is is that you want to shoot for making lots of money now, but when you're older, you want to focus more on keeping the money you have. Incidentally, kudos for getting into seriously saving for retirement when you're young. One of the biggest positive effects you can have on how much you retire with is simply time. The more time your money can sit there, the better. At 26, if you're putting away 10 percent into a Roth, you're doing just fine. If that 5k is more than 10 percent, you'll do better than fine. (That's a rule of thumb, but it's based on a lot of things I've read where people have gamed out various scenarios, as well as my own, cruder calculations I've done in the past)" the whole room basically jumped on me I really have an issue with this. Someone providing advice should offer data, and guidance. Not bully you or attack you.  You offer 3 choices. And I see intelligent answers advising you against #1. But I don't believe these are the only choices. My 401(k) has an S&P fund, a short term bond fund, and about 8 other choices including foreign, small cap, etc. I may be mistaken, but I thought regulations forced more choices. From the 2 choices, S&P and short term bond, I can create a stock bond mix to my liking. With respect to the 2 answers here, I agree, 100% might not be wise, but 50% stock may be too little. Moving to such a conservative mix too young, and you'll see lower returns.  I like your plan to shift more conservative as you approach retirement.   Edit - in response to the disclosure of the fees -  1.18% for Aggressive, .96% for Moderate I wrote an article 5 years back, Are you 401(k)o'ed in which I discuss the level of fees that result in my suggestion to not deposit above the match. Clearly, any fee above .90% would quickly erode the average tax benefit one might expect. I also recommend you watch a PBS Frontline episode titled The Retirement Gamble It makes the point as well as I can, if not better.  The benefit of a 401(k) aside from the match (which you should never pass up) is the ability to take advantage of the difference in your marginal tax rate at retirement vs when earned. For the typical taxpayer, this means working and taking those deposits at the 25% bracket, and in retirement, withdrawing at 15%. When you invest in a fund with a fee above 1%, you can see it will wipe out the difference over time. An investor can pay .05% for the VOO ETF, paying as much over an investing lifetime, say 50 years, as you will pay in just over 2 years.  They jumped on you? People pushing funds with these fees should be in jail, not offering financial advice. "Assuming the numbers work out roughly the same (and you can frankly whip up a spreadsheet to prove that out), a defined benefit scheme that pays out an amount equal to an annuitized return from a 401(k) is better.  The reason is not monetary - it is that the same return is being had at less risk. Put another way, if your defined benefit was guaranteed to be $100/month, and your 401(k) had a contribution that eventually gets to a lump sum that, if annuitized for the same life expectancy gave you $100/month, the DB is better because there is less chance that you won't see the money. Or, put even simpler, which is more likely? That New York goes Bankrupt and is relieved of all pension obligations, or, the stock market underperforms expectations.  Neither can be ruled out, but assuming even the same benefit, lower risk is better. Now, the complication in your scenario is that your new job pays better.  As such, it is possible that you might be able to accumulate more savings in your 401(k) than you might in the DB scheme.  Then again, even with the opportunity to do so, there is no guarantee that you will.  As such, even modelling it out really isn't going to dismiss the key variables. As such, can I suggest a different approach?  Which job is going to make you happier now?  Part of that may be money, part of that may be what you are actually doing.  But you should focus on that question. The marginal consideration of retirement is really moot - in theory, an IRA contribution can be made that would equalize your 401(k), negating it from the equation.  Grant you, there is very slightly different tax treatment, and the phaseout limits differ, but at the salary ranges you are looking at, you could, in theory, make decisions that would have the same retirement outcome in any event. The real question is then not, ""What is the effect in 20 years?"" but rather, which makes you happier now?" "Holding pure cash is a problem for 401K companies because they would then have follow banking rules because they would be holding your cash on their balance sheets. They don't want to be in that business. Instead, they should offer at least one option as a cash equivalent - a money market fund. This way the money is held by the fund, not by 401K administrator. Money Market funds invest in ultra-short term paper, such as overnight loans between banks and other debt instruments that mature in a matter of days. So it is all extremely liquid, as close to ""Money"" as you can get without actually being money.  It is extremely rare for a money market fund to lose value, or ""break the buck."" During the crisis of 2008, only one or two funds broke the buck, and it didn't last long. They had gotten greedy and their short term investments were a little more aggressive as they were trying to get extra returns. In short, your money is safe in a money market fund, and your 401K plan should offer one as the ""cash"" option, or at least it should offer a short-term bond fund. If you feel strongly that your money should be in actual cash, you can always stop contributing to the 401K and put the money in the bank. This is not a good idea though. Unless you're close to retirement, you'll be much better off investing in a well diversified portfolio, even through the ups and downs of the market."