Using an Active/Passive Strategy to Cut Your 401(k) Fees

Using an Active/Passive Strategy to Cut Your 401(k) Fees

Many traditional pension plans use an active/passive strategy that includes investment in actively-managed mutual funds as well as index funds across multiple asset classes. When done correctly, a pension plan implementing this strategy should enjoy greater diversification and stability. But you don’t have to be a participant in a group plan to enjoy the benefits.

How does it Work?

Many individuals with their own 401(k) plans have taken notice and are now following suit by adding index funds for every asset class in their portfolio.

• Someone who has investments in US stocks, non-US stocks, and bonds will allocate some portion of the funds from each of these securities and invest them in index funds of the same type.

• Someone who owns an actively-managed US large cap fund will also invest in an S&P 500 Index or a Total Stock Market Index, which give investors exposure to all 500 large-cap equities or the entire U.S. market.

• Those investing in individual small-cap stocks or emerging market stocks would invest index funds that cover those areas.

Why is Active/Passive Investing Popular?

The reason is simple. If the average actively-managed fund in a 401(k) has expenses of 1.20% and the average index fund has expenses of 0.20%, by dividing, for example, their allocation into half actively-managed and half index funds, an investor can save an average of 0.50% per year on fund expenses. On a $100,000 account balance, that is a savings of $500 per year regardless of market conditions.

Studies have shown that the active/passive strategy offers more than just savings. With greater diversification and market exposure, losses during downturns may be less pronounced, and long-term returns tend to be more consistent. There can be times when an active investments outperform passive ones, and vice versa. The idea is to have a stake in each and enjoy gains wherever they’re occurring.

Does Your 401(k) Have Adequate Exposure?

If your company’s 401(k) doesn’t offer index fund choices across asset classes, request that your employer add them. Plan sponsors are typically open to including low-cost, participant-friendly index funds in their plan. On the other hand, if you’re self-employed or a small business owner with a 401(k) and you’d like a second opinion, our team of MBAs, Certified Public Accountants, and Certified Financial Planners would be more than happy to review it and see if we can suggest any improvements.

OptiFour Integrated Wealth Management

There are many strategies that could improve the performance of your 401(k), and the one introduced above is just one of them. For more information on all of our integrated wealth management solutions, please visit our homepage or contact us today.