Index Funds – should that be the only choice in your 401k plan?


401k with pen on top

Fees matter.  Expenses matter.  And as your plans’ Trustee, you have a fiduciary responsibility to determine that all fees are “reasonable and necessary” for the proper operation of your plan.  Index funds are generally lower-priced, so shouldn’t that be the only thing you offer?

In the plus column for index fund, they generally have lower volatility than actively managed funds.  This is important, as 401k participants tend to get emotional during times of volatility – often selling when things are down, and buying when things are up – not a good way to make money.

Index funds, being at the lower end of the price spectrum, help reduce the likelihood of being sued over high fees.  They also are easier to understand for the participants than an actively managed fund, and reduce the likelihood of having to make periodic fund changes based on underlying performance.

Many reports have shown that only a small percentage of actively managed funds beat the Index.  On February 27, Warren Buffett said on CNBC  that index funds “will do better on balance than what they will get if they go to professionals, because the professionals, after fees, don’t know how to get a better result.” (click here for article)

On the other hand, there are arguments for Actively managed funds.  First and foremost, there are no strong index funds for every asset category.  There are managers that do beat the index on a regular basis, or at least mirror it.

In a market downturn, index funds, by definition, capture the entire downturn, whereas actively managed funds may capture more, or less, of the loss.  Of course, when the market is up, they capture the entire rise as well.

So what’s best?  There are a lot of variables involved – level of participant education and understanding, the need for actively managed sector funds, current fee structure, and other factors.  Consult with an Accredited Investment Fiduciary to get specific advice.