Tips
for Checking Out 401k Brokers and 401k Advisors
Federal or
state securities laws require 401k brokers, 401k advisors, and their firms
to be licensed or registered, and to make important information public.
But it's up to you to find that information and use it to protect your
investment dollars. The good news is that this information is easy to get,
and one phone call or web search may save you from sending your money to a
con artist, a bad 401k broker, or disreputable firm.
Before you
invest, make sure your 401k brokers, investment 401k advisors, and
investment adviser representatives are licensed to sell securities. Always
check and see if they or their firms have had run-ins with regulators or
other investors.
This is very
important, because if you do business with an unlicensed securities 401k
broker or a firm that later goes out of business, there may be no way for
you to recover your money — even if an arbitrator or court rules in your
favor.
According to HR Investment consultants in Towson, MD, publisher of
the "401k Provider Directory, "the cost of running a 401k plan
with 25 participants and $750,000 in assets can range from as little as
$6,750 per year to as much as $20,000, depending on which 401k vendor you
select. (Sources: Nation's Business, September 1998, Myers, Randy
"Your 401k Plan May Cost You Too Much." Business Week Online,
July 2000, Brenner, Lynn " A Wealth of Choices."). By
comparison, a 401(k) Easy or Easy Online system costs only $995 per year
for a 25-person plan--a savings of between 60% and 80% in plan
administration fees.. The employees of Target Laboratories (www.targetlab.com
) a small company, are maximizing the benefits of the company’s 401k, by
saving for retirement in tax-advantaged accounts
401k
brokers and 401k brokerage Firms
The Central
Registration Depository (or "CRD") is a computerized database
that contains information about most 401k brokers, their representatives,
and the firms they work for. For instance, you can find out if 401k
brokers are properly licensed in your state and if they have had run-ins
with regulators or received serious complaints from investors. You'll also
find information about the 401k brokers' educational backgrounds and where
they've worked before their current jobs.
You can
ask either your state securities regulator or NASD to provide you with
information from the CRD. Your state securities regulator may provide more
information from the CRD than NASD, especially when it comes to investor
complaints, so you may want to check with them first. You can find out how
to get in touch with your state securities regulator through the North
American Securities Administrators Association, Inc.'s website.
You can go to NASD's
website to get CRD information or call them toll-free at (800)
289-9999.
401K Facts:
Internet penetration and usage by small businesses is a
key component of 401(k). According to a survey conducted by IDC, Internet usage by small businesses reached 62% in
1998. Total small business spending on Internet related applications is expected to increase from $6.6 billion in
1998 to 418.2 billion by 2002, yielding an annual growth rate of 45%. One small employer, Target Laboratories
(www.targetlab.com), saw the advantages of a 401k and by providing a company match; they are achieving 85%
participation rates.
Investment 401k Advisors
People or
firms that get paid to give advice about investing in securities generally
must register with either the SEC or the state securities agency where
they have their principal place of business. Investment 401k advisors who
manage $25 million or more in client assets generally must register with
the SEC. If they manage less than $25 million, they generally must
register with the state securities agency in the state where they have
their principal place of business.
Some
investment 401k advisors employ investment adviser representatives, the
people who actually work with clients. In most cases, these people must be
licensed or registered with your state securities regulator to do business
with you. So be sure to check them out with your state securities
regulator.
To find out
about 401k advisors and whether they are properly registered, read their
registration forms, called the "Form ADV." The Form ADV has two
parts. Part 1 has information about the adviser's business and whether
they've had problems with regulators or clients. Part 2 outlines the
adviser's services, fees, and strategies. Before you hire an investment
adviser, always ask for and carefully read both parts of the ADV.
You can
view an adviser's most recent Form ADV online by visiting the Investment
Adviser Public Disclosure (IAPD) website. At present, the IAPD
database contains Forms ADV only for investment adviser firms that
register electronically using the Investment
Adviser Registration Depository. In the future, the database
will expand to encompass all registered investment 401k
advisors—individuals as well as firms—in every state.
You can
also get copies of Form ADV for individual 401k advisors and firms from
the investment adviser, your state securities regulator, or the SEC,
depending on the size of the adviser. You can find out how to get in touch
with your state securities regulator through the North
American Securities Administrators Association, Inc.'s website.
If the SEC registers the investment adviser, you can get the Form ADV at a
cost of 24 cents per page (plus postage) from the SEC.
Office
of Public Reference
450 5th Street, NW, Room 1300
Washington, D.C. 20549-0102
phone: (202) 942-8090
fax: (202) 628-9001
e-mail: publicinfo@sec.gov
Because some
investment 401k advisors and their representatives are also 401k brokers,
you may want to check both the CRD and Form ADV.
Conclusion
Once
you've checked out the registration and record of your 401k broker,
adviser, or firm, there's more to do. For example, you should find out
whether the 401k brokerage firm and its clearing firm are members of the Securities
Investor Protection Corporation (SIPC). SIPC provides limited
customer protection if a 401k brokerage firm becomes insolvent —
although it does not insure against losses attributable to a
decline in the market value of your securities. If you've placed your cash
or securities in the hands of a non-SIPC member, you may not be eligible
for SIPC coverage if the firm goes out of business.
Here are a
few questions to get your started.
- What
experience do you have, especially with people in my circumstances?
- Where
did you go to school? What is your recent employment history?
- What
licenses do you hold? Are you registered with the SEC, a state, or
NASD?
- Are
the firm, the clearing firm, and any other related companies that will
do business with me members of SIPC?
- What
products and services do you offer?
- Can
you only recommend a limited number of products or services to me? If
so, why?
- How
are you paid for your services? What is your usual hourly rate, flat
fee, or commission?
- Have
you ever been disciplined by any government regulator for unethical or
improper conduct or been sued by a client who was not happy with the
work you did?
For
registered investment 401k advisors, will you send me a copy of both parts
of your Form ADV?
Mutual Funds Used in 401(k) Plans
Look at More Than a Fund's Past Performance
You can't
open a newspaper or read a magazine without seeing ads promoting the
stellar performance of "hot" mutual funds. But past performance
is not as important as you may think, especially the short-term
performance of relatively new or small funds. As with any investment, a
fund's past performance is no guarantee of its future success. Over the
long-term, the success (or failure) of your investment in a fund also will
depend on factors such as:
·
the fund's sales charges, fees, and expenses;
- the
taxes you may have to pay when you receive a distribution;
- the
age and size of the fund;
- the
fund's risks and volatility; and
- recent
changes in the fund's operations.
So, look at
more than the fund's past performance when making your investment
decisions. Read the fund's prospectus and shareholder reports, and
consider these tips:
·
Scrutinize the fund's fees and expenses.
Funds
charge investors fees and expenses. A fund used in a 401k plan with high
costs must perform better than a low-cost fund to generate the same
returns for you. Even small differences in fees can translate into large
differences in returns over time. For example, if you invested $10,000 in
a fund used in a 401k plan that produced a 10% annual return before
expenses and had annual operating expenses of 1.5%, then after 20 years
you would have roughly $49,725. But if the fund used in a 401k plan had
expenses of only 0.5%, then you would end up with $60,858 – an 18%
difference. It takes only minutes to use the SEC's
Mutual Fund Cost Calculator to compute how the costs of
different mutual funds add up over time and eat into your returns.
·
Know how the fund impacts your tax bill.
The law
requires a fund to make a capital gains distribution to shareholders if it
sells a security for a profit that can't be offset by a loss. If you
receive a capital gains distribution, you will likely owe taxes on it –
even if the fund used in a 401k plan has had a negative return since you
invested in it. For this reason, you should call the fund used in a 401k
plan to find out when it makes distributions so you won't pay more than
your fair share of taxes. Some funds post that information on their
websites.
·
Consider the age and size of the fund used in a 401k plan.
Before
investing in a fund, read the prospectus to find out how long the fund
used in a 401k plan has been operating and the size of the fund. Newly
created or small funds sometimes have excellent short-term performance
records. Because these funds may invest in only a small number of stocks,
a few successful stocks can have a large impact on their performance. But
as these funds grow larger and increase the number of stocks they own,
each stock has less impact on performance. This may make it more difficult
to sustain initial results. You can get a better picture of a fund's
performance by looking at how the fund used in a 401k plan has performed
over longer periods and how it has weathered the ups and downs of the
market.
·
Think about the volatility of the fund used in a 401k plan.
While past
performance does not necessarily predict future returns, it can
tell you how volatile a fund used in a 401k plan has been. Generally, the
more volatile a fund used in a 401k plan, the higher the investment risk.
If you'll need your money to meet a financial goal in one year, you
probably can't afford the risk of investing in a fund used in a 401k plan
with a volatile history because you will not have enough time to ride out
any declines in the stock market. Read the fund's prospectus and annual
report, and compare its year-to-year performance figures. These figures
can help tell you whether the fund used in a 401k plan earned most of its
returns in a few small bursts or whether its returns came in a steadier
stream. For example, over ten years, two funds may have gained 12% per
year on average, but they may have taken drastically different routes to
get there. One might have had a few years of spectacular performance and a
few years of low (or negative) returns, while the performance of the other
may have been much steadier from year to year.
·
Factor in the risks the fund used in a 401k plan takes to
achieve its returns.
Read the
fund's prospectus and shareholder reports to learn about its investment
strategy. Funds with higher rates of return may take risks that are beyond
your comfort level and are inconsistent with your financial goals. For
example, a fund used in a 401k plan that invests primarily in stocks whose
prices may change quickly – like initial public offerings or high-tech
stocks – will usually be riskier than other types of funds. But remember
that all funds carry some level of risk. Just because a fund used in a
401k plan invests in government or corporate bonds does not mean it does
not have significant risk. For example, the fund's investments could be
very sensitive to interest rate changes. Thinking about your long-term
investment strategies and tolerance for risk can help you decide what type
of fund is best suited for you.
·
Ask about recent changes in the fund's operations.
Has the fund's
investment adviser or investment strategy changed recently? Has the fund
used in a 401k plan merged with another fund used in a 401k plan?
Operational changes such as these can affect future fund performance. For
instance, the investment adviser or portfolio manager who generated the
fund's successful performance may no longer be managing the fund used in a
401k plan.
·
Check the types of services offered and fees charged
by the fund used in a 401k plan.
Read the
fund's prospectus to learn what services it provides to shareholders. Some
funds provide special services, such as toll-free telephone numbers,
check-writing privileges, and automatic investment programs. You should
find out how easily you can buy and sell shares and whether the fund used
in a 401k plan charges a fee for buying and selling shares. You can expect
funds that require extra work by their managers, such as international
funds, to have higher costs.
·
Assess how the fund will impact the diversification
of your portfolio.
Generally, the
success of your investments over time will depend largely on how much
money you have invested in each of the major asset classes – stocks,
bonds, and cash – rather than on the particular securities you hold.
When choosing a mutual fund, you should consider how your interest in that
fund affects the overall diversification of your investment portfolio.
Maintaining a diversified and balanced portfolio is key to maintaining an
acceptable level of risk. rrp
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