Let's be blunt: Chances are that your employer sucks at picking mutual funds.
You might not be much better at it, but before you even get a chance to decide which offerings from your 401(k) or other retirement plan you are going to use, your fortunes ride on your employer's ability to supply you with a good plan.
According to new findings from the Center for Retirement Research at Boston College, most employers do a pretty bad job of that task. The study done by Edwin Elton, Martin Gruber and Christopher Blake showed, not surprisingly, that 401(k) plan administrators choose mutual funds that lag comparable indexes. When changing plan offerings, administrators routinely chase returns and do not improve performance.
About the best thing the study could say for employers' fund-picking ability was that the index-lagging issues they chose perform "better than comparable, randomly selected funds." In plain English, that means that the administrators' fund-picking ability is marginally better than nothing, barely surpassing the level of a monkey with darts, a random-name generator and Rusty, the stock-picking steer.
To make matters worse, the inability of administrators to properly select funds is then compounded by plan participants' tendencies to follow investment strategies that add no value, and to chase returns.
In short, it's "garbage in, garbage out," at least if the result you were hoping for was superior investment returns.
That does not mean investors should drop their plans or curtail their retirement savings. Tax rules, employer matching funds and other incentives can make even a bad, costly 401(k) saddled with poor funds into a reasonably effective savings vehicle. Besides, if this is what your employer offers, it may be the only retirement-savings option available.
The study's authors stopped short, however, of drawing what should be the obvious conclusion, the takeaway that applies for any investor with a 401(k). It goes like this: If your employer stinks at picking funds, the minute you no longer are required to be in the plan should be the moment you remove your money.
That does not mean cashing out, but rather transferring your plan assets into a self-directed individual retirement account (IRA), a tax-deferred savings plan you control, and where you choose the investment options rather than relying on what a plan administrator offers.
Gruber, a scholar in residence at New York University's Stern School of Business, said that's precisely what he did upon leaving past employers, rolling his savings into a self-directed IRA at a low-cost, big-name fund shop.
"You have two issues," he said, "starting with 'Are the plan administrators selecting the right funds?' Even if they are, you have to wonder if they are charging you more to own it because of the recordkeeping costs and other expenses that come from being part of the plan."
If you like the funds you own inside your plan, Gruber said, chances are you will like them even more outside of the plan, because you will own them at a lower cost. "Let's say you are afraid to make a decision, you just want to stick with what you own and know, so you just roll the money directly into the same funds, but in a self-directed IRA," Gruber said. "You'd wind up with a better return from the exact same funds."
The next question, of course, is whether you could do more than just cut expenses by selecting better funds.
That's not nearly so sure a thing, as the study made it clear that individual investors aren't necessarily better at picking funds than plan administrators. One key advantage they have, however, is that plan administrators are worried about structuring a plan that is good for the business, which often leads to increased costs passed to employees, while individuals are looking out for themselves.
Statistically speaking, eliminating one layer of potentially poor fund-picking - from the employer - should improve the chances that a retirement portfolio does well.
Since the study showed that 401(k) performance typically lags the benchmarks, investors in plans that don't even offer index choices have a pretty good sign that their available options will be less than ideal. Armed with that information, they should be planning to move the money the moment they leave their job and are able to.
Plenty of workers don't bother to take control of their retirement assets when they leave or retire, thinking the employer has pros picking the funds, or noting that they used those funds to build up their nest egg. They also worry about making mistakes as they roll the money from their retirement plan into a self-directed IRA, mistakes that could create massive tax liabilities.
The good news is that those concerns are overblown in an era when investors can call virtually any fund firm they like and arrange to a rollover quickly and easily, with trained representatives there to make sure the funds get transferred without triggering tax woes.
"It's a simple process to do a rollover," Gruber said, "and it's definitely something that pretty much everyone should be looking at as soon as they can."
Chuck Jaffe, senior columnist for MarketWatch, can be reached at email@example.com.