Keeping close tabs on your 401(k) portfolio is critical.
Your 401(k) plan statement — whether in print, online, or through a voice response system — will tell you whether your account value went up or down during the most recent period. But you’ll need more information to determine whether to stick with your current investment choices as they are or make some changes to improve the chances of meeting your long-term goals.
One of the things you want to know as you evaluate portfolio performance is how well a fund is doing in relation to the other funds making similar types of investments, or striving to achieve a similar goal. That’s where benchmarks come in.
A benchmark is an index or average that reflects the movement of a particular financial market or market sector. It serves as a standard against which to compare the performance of an investment that belongs to the same market or sector. For example, the Standard & Poor’s 500 Index (S&P 500) is the benchmark against which the performance of large-capitalization US stocks and stock funds that invest in those stocks are measured. Likewise, the Russell 2000 Index is the standard for small-company stocks and funds.
Lipper Inc. and Morningstar Inc. also provide standard benchmarks for mutual fund performance. Each of the indexes tracks the performance of funds that invest in a specific group, or subclass, of stocks or bonds, such as large-company growth stocks or US government bonds.
If one of your funds lags behind its appropriate benchmark for more than two or three years, it may be a candidate for replacement. But remember that you can’t make a meaningful assessment unless the benchmark you’re using is the right one for that fund.
Analyzing investment style
A fund manager’s investment style, which influences the types of investments the fund makes, is an important factor influencing its performance. For example, if a fund invests mainly in short-term bonds, it tends to perform the way the short-term bond market performs. Similarly, a fund that invests in large-capitalization growth stocks tends to perform the way the large-cap growth segment of the stock market performs.
But not all funds invest in only one segment of the market. For example, a US stock fund might own both large-cap core value and growth stocks, and keep a percentage of its holdings in cash.
Further, no two funds own exactly the same investments in exactly the same proportions, or produce exactly the same return.
For example, a stock mutual fund that describes itself as a growth fund doesn’t necessarily produce the same return as other growth funds. For similar reasons, a growth fund may not produce the same return as an index that tracks growth investments.
To create benchmarks for measuring funds that make diverse investments, companies that specialize in analyzing fund performance use a process called style analysis or returns-based style analysis. This methodology focuses on the way a fund’s returns behave in relation to the returns of a number of different asset classes. That information, in turn, helps to explain the fund’s past performance as well as anticipate how the fund may perform in the future.
Fees: be prepared
The returns published in the financial press for a particular mutual fund may differ from the return that’s reported for the same fund in your portfolio statement. That happens for a number of reasons.
Part of the answer is fees. Unless your employer covers the entire administrative cost of the plan, you may be paying a share of those fees, fees for recordkeeping services your plan offers, or loan fees if you’ve borrowed from your plan. Those fees are subtracted before your return is reported on your statement.
Fees vary from plan to plan, based in part on who the provider is and in part on the size of the plan. Large plans tend to have lower fees — sometimes much lower — than smaller plans. That’s because the more money that flows into the plan, the better the deal the provider is willing to offer to keep the sponsor’s business.
Other cost issues
Investment management fees, which are figured as a percentage of your assets, are also subtracted before return is reported. Fees for different investments vary, typically based on how active the management is and the kinds of investments the fund makes. For example, stock funds tend to have higher fees than bond funds, and passively managed index funds tend to have the lowest fees of all.
Similarly, your account activity, particularly the timing of money flowing into — and sometimes out of — your account, and the costs of the transactions you make, also affect return. For example, if your contribution hits the fund on a day when prices have jumped or dropped, your money will buy a different number of shares than it would have if your purchase had gone through a day earlier or later. And if you do a lot of buying and selling, you may pay substantial sales charges or transaction fees.
You can get more information about 401(k) fees and expenses from the US Department of Labor. A booklet called “A Look at 401(k) Fees…for Employees” is available on its website.
You can find other information about fund fees at FINRA and SEC. You can also encourage your employer to compare the costs of different 401(k) plans using a form developed by the US Department of Labor and the mutual fund, banking, and insurance industries, all of which sponsor various plans. This form and the Employee Benefits Security Administration’s (EBSA) guide, “Understanding Retirement Plan Fees and Expenses,” are available from the department.
How Is 401k Performance Calculated? Performance Factors Explained by Inna Rosputnia
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