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401(k)plans

Why Mutual Funds?

Mutual funds can be a good way for people to invest in stocks, bonds, and other securities. Why?

  • Mutual funds are managed by professional money managers.
  • By owning shares in a mutual fund instead of buying individual stocks or bonds directly, your investment risk is spread out.
  • Because your mutual fund buys and sells large amounts of securities at a time, its costs are often lower than what you would pay on your own.

This document explains the basics of mutual fund investing -- how a mutual fund works, what factors to consider before investing, and how to
avoid common pitfalls.

There are sources of information that you should consult before you invest in mutual funds. The most important of these is the prospectus of any
fund you are considering. The prospectus is the fund's selling document and contains information about costs, risks, past performance, and the
fund's investment goals. Request a prospectus from a fund, or from a financial professional if you are using one. Read the prospectus before
you invest.

Before you buy a mutual fund, make sure it is right for you.

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.

How Mutual Funds Work

A mutual fund is a company that brings together money from many people and invests it in stocks, bonds, or other securities. (The combined holdings of stocks, bonds, or other securities and assets the fund owns are known as its portfolio.) Each investor owns shares, which represent a part of these holdings.

How To Buy and Sell Shares

You can buy some mutual funds by contacting them directly. Others are sold mainly through brokers, banks, financial planners, or insurance agents. All mutual funds will redeem (buy back) your shares on any business day and must send you the payment within seven days.

You can find out the value of your shares in the financial pages of major newspapers; after the fund's name, look for the column marked "NAV."

TERMS TO KNOW

Net Asset Value per share (NAV): NAV is the value of one share in a fund.

When you buy shares, you pay the current NAV per share, plus any sales charge (also called a sales load). When you sell your shares, the fund will pay you NAV less any other sales load. A fund's NAV goes up or down daily as its holdings change in value.

Example: You invest $1,000 in a mutual fund with an NAV of $10.00. You will therefore own 100 shares of the fund. If the NAV drops to $9.00 (because the value of the fund's portfolio has dropped), you will still own 100 shares, but your investment is now worth $900. If the NAV goes up to $11.00, your investment is worth $1,100. (This example assumes no sales charge.)

How Funds Can Earn You Money

You can earn money from your investment in three ways.

First, a fund may receive income in the form of dividends and interest on the securities it owns. A fund will pay its shareholders nearly all of the income it has earned in the form of dividends.

Second, the price of the securities a fund owns may increase. When a fund sells a security that has increased in price, the fund has a capital gain. At the end of the year, most funds distribute these capital gains (minus any capital losses) to investors.

Third, if a fund does not sell but holds on to securities that have increased in price, the value of its shares (NAV) increases. The higher NAV reflects the higher value of your investment. If you sell your shares, you make a profit (this also is a capital gain). Usually funds will give you a choice: the fund can send you payment for distributions and dividends, or you can have them reinvested in the fund to buy more shares, often without paying an additional sales load.

TAXES

You will owe taxes on any distributions and dividends in the year you receive them (or reinvest them). You will also owe taxes on any capital gains you receive when you sell your shares. Keep your account statements in order to figure out your taxes at the end of the year.

If you invest in a tax-exempt fund (such as a municipal bond fund), some or all of your dividends will be exempt from federal (and sometimes state and local) income tax. You will, however, owe taxes on any capital gains.

Kinds of Mutual Funds

You take risks when you invest in any mutual fund. You may lose some or all of the money you invest (your principal), because the securities held by a fund go up and down in value. What you earn on your investment also may go up or down.

Each kind of mutual fund has different risks and rewards. Generally, the higher the potential return, the higher the risk of loss.

Before you invest, decide whether the goals and risks of any fund you are considering are a good fit for you. To make this decision, you may need the help of a financial adviser. There are also investment books and services to guide you.

The three main categories of mutual funds are money market funds, bond funds, and stock funds. There are a variety of types within each category.

1. Money Market Funds have relatively low risks, compared to other mutual funds. They are limited by law to certain high- quality, short-term investments. Money market funds try to keep their value (NAV) at a stable $1.00 per share, but NAV may fall below $1.00 if their investments perform poorly. Investor losses have been rare, but they are possible.

A WORD ABOUT BANKS AND MUTUAL FUNDS

Banks now sell mutual funds, some of which carry the bank's name. But mutual funds sold in banks, including money market funds, are not bank deposits. Don't confuse a "money market fund" with a "money market deposit account." The names are similar, but they are completely different:

  • A money market fund is a type of mutual fund. It is not guaranteed, and comes with a prospectus.
  • A money market deposit account is a bank deposit. It is guaranteed, and comes with a Truth in Savings form.

2. Bond Funds (also called Fixed Income Funds) have higher risks than money market funds, but seek to pay higher yields. Unlike money market funds, bond funds are not restricted to high-quality or short-term investments. Because there are many different types of bonds, bond funds can vary dramatically in their risks and rewards.

Most bond funds have credit risk, which is the risk that companies or other issuers whose bonds are owned by the fund may fail to pay their debts (including the debt owed to holders of their bonds). Some funds have little credit risk, such as those that invest in insured bonds or U.S. Treasury bonds. But be careful: nearly all bond funds have interest rate risk, which means that the market value of the bonds they hold will go down when interest rates go up. Because of this, you can lose money in any bond fund, including those that invest only in insured bonds or Treasury bonds.

Long-term bond funds invest in bonds with longer maturities (length of time until the final payout). The values (NAVs) of long-term bond funds can go up or down more rapidly than those of shorter-term bond funds.

3. Stock Funds (also called Equity Funds) generally involve more risk than money market or bond funds, but they also can offer the highest returns. A stock fund's value (NAV) can rise and fall quickly over the short term, but historically stocks have performed better over the long term than other types of investments.

Not all stock funds are the same. For example, growth funds focus on stocks that may not pay a regular dividend but have the potential for large capital gains. Others specialize in a particular industry segment such as technology stocks.

A WORD ABOUT DERIVATIVES

Some funds may face special risks if they invest in derivatives. Derivatives are financial instruments whose performance is derived, at least in part, from the performance of an underlying asset, security or index. Their value can be affected dramatically by even small market movements, sometimes in unpredictable ways.

There are many types of derivatives with many different uses. They do not necessarily increase risk, and may in fact reduce risk. A fund's prospectus will disclose how it may use derivatives. You may also want to call a fund and ask how it uses these instruments.

Comparing Different Funds

Once you identify the types of funds that interest you, it is time to look at particular funds in those categories.

Viewing Past Performance

A fund's past performance is not as important as you might think. Advertisements, rankings, and ratings tell you how well a fund has performed in the past. But studies show that the future is often different. This year's "number one" fund can easily become next year's below average fund. (NOTE: Although past performance is not a reliable indicator of future performance, volatility of past returns is a good indicator of a fund's future volatility.)

Tips For Comparing Performance

  • Check the fund's total return. You will find it in the Financial Highlights, near the front of the prospectus. Total return measures increases and decreases in the value of your investment over time, after subtracting costs.
  • See how total return has varied over the years. The Financial Highlights in the prospectus show yearly total return for the most recent 10-year period. An impressive 10-year total return may be based on one spectacular year followed by many average years. Looking at year-to-year changes in total return is a good way to see how stable the fund's returns have been.

Comparing Costs

Costs are important because they lower your returns. A fund that has a sales load and high expenses will have to perform better than a low-cost fund, just to stay even with the low-cost fund.

Find the fee table near the front of the fund's prospectus, where the fund's costs are laid out. You can use the fee table to compare the costs of different funds.

The fee table breaks costs into two main categories:

1. sales loads and transaction fees (paid when you buy, sell, or exchange your shares), and

2. ongoing expenses (paid while you remain invested in the fund).

Sales Loads

The first part of the fee table will tell you if the fund charges any sales loads.

No-load funds do not charge sales loads. When you buy no-load funds, you make your own choices, without the assistance of a financial professional. There are no-load funds in every major fund category. Even no-load funds have ongoing expenses, however, such as management fees.

When a mutual fund charges a sales load, it usually pays for commissions to people who sell the fund's shares to you, as well as other marketing costs. Sales loads buy you a broker's services and advice; they do not assure superior performance. In fact, funds that charge sales loads have not performed better on average (ignoring the loads) than those that do not charge sales loads.

Additional non-profit websites that include relevant unbiased information about 401k plans include: www.mutualfunds-401k.com and www.run-it-yourself401k.com

TERMS TO KNOW

Front-end load: A front-end load is a sales charge you pay when you buy shares. This type of load, which by law cannot be higher than 8.5% of your investment, reduces the amount of your investment in the fund.

Example: If you have $1,000 to invest in a mutual fund with a 5% front-end load, $50 will go to pay the sales charge, and $950 will be invested in the fund.

Back-end load: A back-end load (also called a deferred load) is a sales charge you pay when you sell your shares. It usually starts out at 5% or 6% for the first year and gets smaller each year after that until it reaches zero (say, in year six or seven of your investment).

Example: You invest $1,000 in a mutual fund with a 6% back-end load that decreases to zero in the seventh year. Let's assume for the purpose of this example that the value of your investment remains at $1,000 for seven years. If you sell your shares during the first year, you only will get back $940 (ignoring any gains or losses). $60 will go to pay the sales charge. If you sell your shares during the seventh year, you will get back $1,000.

Ongoing Expenses

The second part of the fee table tells you the kinds of ongoing expenses you will pay while you remain invested in the fund. The table shows expenses as a percentage of the fund's assets, generally for the most recent fiscal year. Here, the table will tell you the management fee (which pays for managing the fund's portfolio), along with any other fees and expenses.

High expenses do not assure superior performance. Higher expense funds do not, on average, perform better than lower expense funds. But there may be circumstances in which you decide it is appropriate for you to pay higher expenses. For example, you can expect to pay higher expenses for certain types of funds that require extra work by its managers, such as international stock funds, which require sophisticated research. You may also pay higher expenses for funds that provide special services, like toll-free telephone numbers, check-writing and automatic investment programs.

A difference in expenses that may look small to you can make a big difference in the value of your investment over time.

Example: Say you invest $1,000 in a fund. Let's assume for the purpose of this example that you receive a flat rate of return of 5% before expenses. If the fund has expenses of 1.5%, after 20 years you would end up with roughly $1,990. If the fund has expenses of 0.5%, you would end up with more than $2,410. This is a 22% difference.

TERMS TO KNOW

Rule 12b-1 fee: One type of ongoing fee that is taken out of fund assets has come to be known as a rule 12b-1 fee. It most often is used to pay commissions to brokers and other salespersons, and occasionally to pay for advertising and other costs of promoting the fund to investors. It usually is between 0.25% and 1.00% of assets annually.

Funds with back-end loads usually have higher rule 12b-1 fees. If you are considering whether to pay a front-end load or a back- end load, think about how long you plan to stay in a fund. If you plan to stay in for six years or more, a front-end load may cost less than a back-end load. Even if your back-end load has fallen to zero, over time you could pay more in rule 12b-1 fees than if you paid a front-end load.

Tips For Comparing Costs

  • Beware of a salesperson who tells you, "This is just like a no-load fund." Even if there is no front-end load, check the fee table in the prospectus to see what other loads or fees you may have to pay.
  • Check the fee table to see if any part of a fund's fees or expenses has been waived. If so, the fees and expenses may increase suddenly when the waiver ends (the part of the prospectus after the fee table will tell you by how much).
  • Many funds allow you to exchange your shares for shares of another fund managed by the same adviser. The first part of the fee table will tell you if there is any exchange fee.

Shop wisely. Compare fees and expenses before you invest.

BACKGROUND

The Investment Company Institute (ICI), the trade association of the mutual fund industry, estimates that at the end of 1998 assets in 401(k) plans stood at $1.41 trillion. These plan assets grew at an average rate of 18% per year during the 1990s. Plansponsor.com reports that they rose nearly 22% in the final year of the decade, from $1.7 trillion in 1999 to $2.1 trillion in 2000. Average salary deferral rates of plan participants have also been on an exponential rise. The Profit Sharing 401(k) Council of America (PSCA) reports that the average salary deferral rate grew from 4.2% in 1991 to 5.4% by 1999, an increase of more than 28%

Mutual Fund Investment Companies have provided the best 401(k) option for small and medium-sized businesses. Plans offered by mutual fund companies tend to be tightly bundled, meaning the administration and administrative functions (which may be subcontracted out or conducted in-house by the mutual fund company) are designed to work exclusively with the mutual fund's proprietary investments.

Mutual fund companies make most of their money by acquiring, holding, and managing investment assets in their various fund portfolios. In some cases, 401(k) administration may be offered to the employer-plan sponsor at a price below its actual cost to the mutual fund company as a device for attracting and holding new assets, on the assumption that 401(k) savings tend to be long-term, giving the mutual fund company many years to collect management fees.

Mutual fund 401(k) plans have been aggressively promoted to the small business communities both by no-load fund companies (e.g., Fidelity Funds, Vanguard Funds) and load fund companies (e.g., MFS, John Hancock, Putnam). Recent news articles, however, have reported a trend among many of these plan vendors to abandon the very small plans because the costs of providing 401(k) services for such plans versus the revenue generated from them has proved to be a losing proposition. For economic reasons, the sales target for mutual fund bundled plans has been raised, and now companies with fewer than 100 employees are not being actively solicited by most of these vendors.

Mutual fund companies make their money by acquiring, holding, and managing inevitable assets in their various fund portfolios. In some cases, the bundled 401(k) administration may offer to small businesses at a loss as a device for attracting and holding new assets, on the assumption that 401(k) investing tends to be long-term, giving the mutual fund company many years to collect management fees.

Fees and Expenses of Mutual Funds Used in 401k Plans

As with any business, running a mutual fund involves costs. For example, there are costs incurred in connection with particular investor transactions, such as investor purchases, exchanges, and redemptions. There are also regular fund operating costs that are not necessarily associated with any particular investor transaction, such as investment advisory fees, marketing and distribution expenses, brokerage fees, and custodial, transfer agency, legal, and accountants fees.
Some funds used in 401k plans cover the costs associated with an individual investor's transactions and account by imposing fees and charges directly on the investor at the time of the transactions (or periodically with respect to account fees). These fees and charges are identified in a fee table, located near the front of a fund's prospectus , under the heading "Shareholder Fees."
Funds used in 401k plans typically pay their regular and recurring, fund-wide operating expenses out of fund assets, rather than by imposing separate fees and charges on investors. (Keep in mind, however, that because these expenses are paid out of fund assets, investors are paying them indirectly.) These expenses are identified in the fee table in the fund's prospectus under the heading "Annual Fund Operating Expenses."
A frequently asked question is whether the SEC imposes any specific limits on the size of the fees that a fund may charge. The short answer is the SEC generally does not, although the SEC limits redemption fees to 2% in most situations. The National Association of Securities Dealers, Inc. (NASD), however, does impose limits on some fees.
Under the heading of "Shareholder Fees," you will find:

Sales Loads (including Sales Charge (Load) on Purchases and Deferred Sales Charge (Load))

Redemption Fee

Purchase Fee

Exchange Fee

Account Fee

Under the heading of "Annual Fund Operating Expenses," you will find:

Management Fees

Distribution [and/or Service] (12b-1) Fees

Other Expenses

Total Annual Fund Operating Expense

Shareholder Fees

Sales Loads

Funds used in 401k plans that use brokers to sell their shares must compensate the brokers. Funds used in 401k plans may do this by imposing a fee on investors, known as a "sales load" (or "sales charge (load)"), which is paid to the selling brokers. In this respect, a sales load is like a commission investors pay when they purchase any type of security from a broker. Although sales loads most frequently are used to compensate outside brokers that distribute fund shares, some funds used in 401k plans that do not use outside brokers still charge sales loads.

The SEC does not limit the size of sales load a fund may charge, but the NASD does not permit mutual fund sales loads to exceed 8.5%. The percentage is lower if a fund imposes other types of charges. Most funds used in 401k plans do not charge the maximum.

There are two general types of sales loads-a front-end sales load investors pay when they purchase fund shares and a back-end or deferred sales load investors pay when they redeem their shares.

Sales Charge (Load) on Purchases

The category "Sales Charge (Load) on Purchases" in the fee table includes sales loads that investors pay when they purchase fund shares (also known as "front-end sales loads"). The key point to keep in mind about a front-end sales load is it reduces the amount available to purchase fund shares. For example, if an investor writes a $10,000 check to a fund for the purchase of fund shares, and the fund has a 5% front-end sales load, the total amount of the sales load will be $500. The $500 sales load is first deducted from the $10,000 check (and typically paid to a selling broker), and assuming no other front-end fees, the remaining $9,500 is used to purchase fund shares for the investor.

Deferred Sales Charge (Load)

The category "Deferred Sales Charge (Load)" in the fee table refers to a sales load that investors pay when they redeem fund shares (that is, sell their shares back to the fund). You may also see this referred to as a "deferred" or "back-end" sales load. When an investor purchases shares that are subject to a back-end sales load rather than a front-end sales load, no sales load is deducted at purchase, and all of the investors' money is immediately used to purchase fund shares (assuming that no other fees or charges apply at the time of purchase). For example, if an investor invests $10,000 in a fund with a 5% back-end sales load, and if there are no other "purchase fees," the entire $10,000 will be used to purchase fund shares, and the 5% sales load is not deducted until the investor redeems his or her shares, at which point the fee is deducted from the redemption proceeds.

Typically, a fund calculates the amount of a back-end sales load based on the lesser of the value of the shareholder's initial investment or the value of the shareholder's investment at redemption. For example, if the shareholder initially invests $10,000, and at redemption the investment has appreciated to $12,000, a back-end sales load calculated in this manner would be based on the value of the initial investment-$10,000-not on the value of the investment at redemption. Investors should carefully read a fund's prospectus to determine whether the fund calculates its back-end sales load in this manner.

The most common type of back-end sales load is the "contingent deferred sales load," also referred to as a "CDSC," or "CDSL." The amount of this type of load will depend on how long the investor holds his or her shares and typically decreases to zero if the investor hold his or her shares long enough. For example, a contingent deferred sales load might be 5% if an investor holds his or her shares for one year, 4% if the investor holds his or her shares for two years, and so on until the load goes away completely. The rate at which this fee will decline will be disclosed in the fund's prospectus.

A fund or class with a contingent deferred sales load typically will also have an annual 12b-1 fee.

A Word About No-Load Funds used in 401k plans

Some funds used in 401k plans call themselves "no-load." As the name implies, this means that the fund does not charge any type of sales load. As described above, however, not every type of shareholder fee is a "sales load," and a no-load fund may charge fees that are not sales loads. For example, a no-load fund is permitted to charge purchase fees, redemption fees, exchange fees, and account fees, none of which is considered to be a "sales load." In addition, under NASD rules, a fund is permitted to pay its annual operating expenses and still call itself "no-load," unless the combined amount of the fund's 12b-1 fees or separate shareholder service fees exceeds 0.25% of the fund's average annual net assets.

Redemption Fee

A redemption fee is another type of fee that some funds used in 401k plans charge their shareholders when the shareholders redeem their shares. Although a redemption fee is deducted from redemption proceeds just like a deferred sales load, it is not considered to be a sales load. Unlike a sales load, which is generally used to pay brokers, a redemption fee is typically used to defray fund costs associated with a shareholder's redemption and is paid directly to the fund, not to a broker. The SEC generally limits redemption fees to 2%.

Purchase Fee

A purchase fee is another type of fee that some funds used in 401k plans charge their shareholders when the shareholders purchase their shares. A purchase fee differs from, and is not considered to be, a front-end sales load because a purchase fee is paid to the fund (not to a broker) and is typically imposed to defray some of the fund's costs associated with the purchase.

Exchange Fee

An exchange fee is a fee that some funds used in 401k plans impose on shareholders if they exchange (transfer) to another fund within the same fund group.

Account Fee

An account fee is a fee that some funds used in 401k plans separately impose on investors in connection with the maintenance of their accounts. For example, some funds used in 401k plans impose an account maintenance fee on accounts whose value is less than a certain dollar amount.

Annual Fund Operating Expenses

Management Fees

Management fees are fees that are paid out of fund assets to the fund's investment adviser for investment portfolio management, any other management fees payable to the fund's investment adviser or its affiliates, and administrative fees payable to the investment adviser that are not included in the "Other Expenses" category (discussed below).

Distribution [and/or Service] (12b-1) Fees

This category identifies so-called "12b-1 fees," which are fees paid by the fund out of fund assets to cover distribution expenses and sometimes shareholder service expenses.

"12b-1 fees" get their name from the SEC rule that authorizes their payment. The rule permits a fund to pay distribution fees out of fund assets only if the fund has adopted a plan (12b-1 plan) authorizing their payment. "Distribution fees" include fees paid for marketing and selling fund shares, such as compensating brokers and others who sell fund shares, and paying for advertising, the printing and mailing of prospectuses to new investors, and the printing and mailing of sales literature.

The SEC does not limit the size of 12b-1 fees that funds used in 401k plans may pay. But under NASD rules, 12b-1 fees that are used to pay marketing and distribution expenses (as opposed to shareholder service expenses) cannot exceed 0.75 percent of a fund's average net assets per year.

Some 12b-1 plans also authorize and include "shareholder service fees," which are fees paid to persons to respond to investor inquiries and provide investors with information about their investments. Unlike distribution fees, a fund may pay shareholder service fees without adopting a 12b-1 plan. If shareholder service fees are part of a fund's 12b-1 plan, these fees will be included in this category of the fee table. If shareholder service fees are paid outside a 12b-1 plan, then they will be included in the "Other expenses" category, discussed below. The NASD imposes an annual .25% cap on shareholder service fees (regardless of whether these fees are authorized as part of a 12b-1 plan).

Other Expenses

Included in this category are expenses not included in the categories "Management Fees" or "Distribution [and/or Service] (12b-1) Fees." Examples include: shareholder service expenses that are not included in the "Distribution [and/or Service] (12b-1) Fees" category; custodial expenses; legal expenses; accounting expenses; transfer agent expenses; and other administrative expenses.

Total Annual Fund Operating Expense

This line of the fee table is the total of a fund's annual fund operating expenses, expressed as a percentage of the fund's average net assets.

A Word About Mutual Fund Fees and Expenses

As you might expect, fees and expenses vary from fund to fund. A fund 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 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 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 used in 401k plans add up over time and eat into your returns.

The three primary reasons why 80% of America's small businesses do not offer 401(k) plans to their employees are: (a) perceived cost of employer-sponsored retirement plans, (b) perceived complexity of company-sponsored retirement plans, and (c) limited investment options. Mutual fund companies offering 401(k) plans to small businesses do so by pre-packaging administration with their proprietary fund investments; this pre-packaged approach, called "bundled 401(k)" tends to be pricey for small companies, limited features and limited investment options. Employees who participate in bundled 401(k) plans typically do not have access to investments not offered by the mutual fund company, and do not have access to the most popular investment option today-the individual self-directed discount brokerage account.

Unfortunately, however, these vendors were not equally well prepared to service the needs of the smaller companies: the plans they designed and the packages they offer are not always appropriate in price, substance, or style, and their pamphlets and publications are often too dry, legalistic, and expensive. Perhaps it is because most of these vendors are large companies themselves that they have difficulty designing 401(k) plans that embody the entrepreneurial, "do-it-yourself" spirit so prevalent in many small and medium-sized companies.

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%.

Financial institutions such as banks, brokerage firms, and trust companies (e.g., Union Bank of California, Wells Fargo Bank, Merrill Lynch, First Trust) offer 401(k) administration services that tend to be less expensive than services offered by benefit consulting firms. The main target of the financial institutions is also the Fortune-500-sized organization; however, they offer the advantage of more closely linking the investment vehicles with plan administration and recordkeeping. They can achieve vertical integration of investments and administration because banks, brokerages, and some trust companies offer a predefined group of proprietary and other mutual funds investments that pay 12b-1 and other asset-based fees to these plan providers, helping offset the cost of providing plan administration. Today these often "hidden" asset-based fees are coming under close scrutiny by government agencies and the press as being unfair to plan participants. As media and governmental investigation pressures mounts, financial institutions will need to find other ways to offset or cut their administration costs-401(k) Enginuity will become a more and more attractive alternative to traditional administration platforms as time goes on.

401(k) plans must be sponsored by an employer. Millions of American workers can't take advantage of the 401(k)'s many attractive attributes because, for one reason or another - typically high plan costs, plan inflexibility, and/or prohibitive minimum participation standards - their employers do not sponsor a plan. In particular, very small, small, and medium-sized companies have found sponsorship difficult if not impossible. Some 89% of very small companies (10-50 employees), 72% of small companies (50 - 100 employees), and 66% of medium-sized companies (100 - 250 employees) do not have 401(k) plans (Census Bureau figures). These figures do not include the companies that have fewer than 10 employees, what might be called "micro" companies.

The tax deferral of 401k has a huge compounding effect: $150 per month put into a typical taxable savings account paying 8% annual interest will grow to $42,034 by the end of 20 years (assuming a combined federal and state personal income tax rate of 34%). In a 401(k), however, the same deposits earning the same rate of return during the same 20 years will yield $88,353 . Even if that amount is taxed at the 34% rate when the money is withdrawn from the plan, which is unlikely if the participant is retired, the 401(k) participant will walk away with more than $16,000 compared to the equivalent non-401(k) investment return.

401(k) plans have the highest annual contribution ceiling of any of the tax-deferred defined contribution savings programs (IRAs, SEPs, etc.). More money contributed equals more money earning money, equals more money in the account 20 years later. Add to this earning potential the convenience of contributions made through automatic payroll deductions and it's easy to see why 401(k)s are so popular.

The average 401K account balance at the end of 1998 was $47,000 per participant, up 26% from 1996, according to the ICI and the Employee Benefit Research Institute. On average, 78% of eligible employees will participate in a 401(k) plan if one is made available, with the number of participants growing from 19.5 million in 1990 to 53.2 million in 2000. Some of the increase in participation rates is due to the introduction of "negative election," which allows an employer to automatically enroll employees into the 401(k) when they meet the plan's eligibility requirements. The negative election deferral rate and investment(s) must be defined ahead of time, and the employee must be immediately notified of his or her participation status. Automatic enrollment programs are sanctioned by the IRS under ERISA as long as the employee has ample ability to cease enrollment at will.

Traditional 401(k) plan vendors did not think much about approaching smaller companies until recently, and did so then only because they recognized that the larger-company market was pretty well saturated. When they did turn their attention to the smaller and mid-sized plan market, they were well prepared with a library of useful educational materials for potential and actual plan participants. Participation is participation, after all, whether it is in a plan with 50 participants or 50,000

Other Sources of Information

Read the sections of the prospectus that discuss the risks, investment goals, and investment policies of any fund that you are considering. Funds of the same type can have significantly different risks, objectives and policies

All mutual funds must prepare a Statement of Additional Information (SAI, also called Part B of the prospectus). It explains a fund's operations in greater detail than the prospectus. If you ask, the fund must send you an SAI.

You can get a clearer picture of a fund's investment goals and policies by reading its annual and semi-annual reports to shareholders. If you ask, the fund will send you these reports.

You can also research funds at most libraries. Helpful resources include fund investment books, investor magazines and newspapers. The fund companies themselves can also provide information.


401(k)plans

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