INVESTING: Employees too often stuck with onerous 401(k) plans

Since the early 1980s, nearly every U.S. employee has been exposed to the mighty 401(k) plan.

I used to participate in one when I was a stockbroker in New York. The fact that I am in the business gives me a detailed look at what happens in the 401(k) world, and I am appalled.

Here’s how it works. You start working for a firm and within six months you can participate in its 401(k) plan. You get all the paperwork and hand it back to human resources, then your next paycheck is a little lighter but you are now investing in the stock market!

Through most of the ’80 s and ’90s, most employees didn’t look at their plans; they simply invested contributions every month and let ’em go. I really expected the last bear market to shake things up, but investors are still being led like sheep to the slaughter. The 401(k) business is a racket, and it’s time the club was turned upside down!

Investors in 401(k) plans can put their money in 10 to 25 mutual funds, depending on the plan. The fund choices typically range from large-cap U.S. equities to small-cap and foreign funds.

One of the great wrongs here stems from the limited choice. The market is segmented today, and investors need access to several dozen choices if they want to perform well.

Another problem: Mutual funds charge on average 1.25 percent a year. A lot of money is being made, except by you.

The recent mutual fund timing scandals exposed other abuses. Institutional investors cut deals with mutual funds to buy after the market closed, but at the closing price.

Say a mutual fund owns lots of Microsoft, and at 4:30 p.m. the company announces great earnings. The stock closed at $25, but it will open the next day at $27. The hedge fund buys the fund at today’s price knowing it can sell higher tomorrow.

This is illegal and should be, but has nothing to do with the timing rules mutual fund firms are imposing on investors now. The firms are simply borrowing the language New York Attorney General Eliot Spitzer used, and again investors are losing out.

Here’s a quote from a letter from a 401(k) administrator and broker-dealer: “Do you know that fund managers reserve the right to refuse purchase requests that fall under the description of market timing? Well, they do. Market timing increases fund expenses while lowering the return for shareholders.”

This letter misses a key point. If a broker’s expenses are too high, it is the broker’s job to fix the expense problem, not the client’s.

By limiting choices and prohibiting frequent trading, the fund firms tell us they are saving us from ourselves. That’s the same thing Castro tells his people every day.

Here is a simple solution, one mutual fund firms fear: 401(k) admistrators should replace all their mutual funds with exchange-traded funds, or ETFs. There are more than 300 ETFs now, and they charge a fraction of what funds charge.

Offering ETFs will give investors far more choices and the ability to trade intraday. After you read this, charge into your human resources department and demand changes.