Managing your 401k plan isn't easy, is it?

You're not alone. It's a problem for all 42 million people with accounts. It's also difficult for the experts. As evidence I submit a list of average 401k plan results for a variety of financial service organizations. The list shows their returns for 1998, a year most now remember as the proverbial 'good old days.'

The list comes from Brooks Hamilton; a Dallas benefits attorney and 401k plan record keeper. He made it by going to a website that publishes the form 5500 data on 401k plans. Then he calculated the return for the plan as a whole and found that they ranged from a small loss to less than 7 percent. (The website is

How Some Major Advice Providers Own 401k Plans Performed in 1998

Company Calculated Return on Plan Assets
Bank of America 6.5 percent
Citigroup 4.7
Hewitt -1.6*
Merrill Lynch 2.7
Morningstar 6.8
Prudential 6.9

Source: Brooks Hamilton and Associates. Note * results reflect a plan year ending September 1998, a period when the S&P 500 index was up 9.8 percent.

Since the S&P 500 Index provided a blockbuster total return of 28.6 percent in the same period a casual observer might have serious misgivings about the advisors--- if their employees can't get good returns in their own plans, how can they be expected to do it for their clients? Why are the average returns so low in a year when the index did so well?

Looking for explanation and analysis, I called Bank of America, Hewitt, Merrill Lynch and Morningstar. With the exception of Morningstar, it was slow going, with one public relations person asking, "Why would we do that?"

John Rekenthaler, head of research at Morningstar, returned my call and directed his attention to the question with forensic calm. In the process, he revealed some unrecognized levers that can have a powerful effect on what we achieve in our 401k plans.

Here are the levers:

1. Know what you are measuring. "1998 and 1999! Those were record-book years for large growth stocks. It was an extremely narrow market and seems to be the reverse of what we experienced in 2000 and so far in 2001. In fact, it's just possible that 1998 had the greatest discrepancy of one style box over another--- growth versus value, small versus large--- of any year," he observed.

Using the Morningstar database, we found that while the S&P 500 index provided a return of 28.6 percent, the average domestic equity fund provided a return only half as large, 14.5 percent. Similarly, while the Lehman Brothers Bond Market Index provided a return of 8.67 percent, the average taxable bond fund returned only 5.34 percent. As a consequence, any 401k plan that didn't offer index funds as choices had a lower overall return in 1998.

2. Results can be powerfully affected by the performance of a single volatile fund. "Morningstar employees are young, more risk-oriented, and tend to be invested in growth. We may have had PBHG Growth (fund) and Brandywine (fund)." In fact, these two mid-cap growth funds had miserable returns in 1998, only 0.59 percent for PBHG Growth and minus 0.65 percent for Brandywine.

3. An investment style may be in, or out, in any single year. In 1998 the average large growth fund provided a return of 33.20 percent, nearly 3 times the 13.2 percent return of the average large value fund. To the extent that a plan provided value fund options, its average return was penalized in 1998. The same can be said for small versus large stocks. In 1998 the average small cap stock fund lost 0.68 percent on average while large cap stock funds gained 22.58 percent.

"That's always the danger of looking at a single year" Mr. Rekenthaler said. "That's why there is so much change in the best and worst (funds) lists that appear in the magazines."

4. Plan performance will reflect what's offered. While that may seem obvious, it has subtle ramifications. In 1998, a simple plan that offered a stock index and a bond index would have produced banner results because it was a poor year for almost everything else. A more sophisticated plan with a full array of asset classes--- like the plan Morningstar offers its employees--- would have had a lower return.

The reason might be called 'The Menu Effect.' Research by behavioral economist Richard Thaler has shown that 401k plan participant choices tend to reflect the menu of funds offered. A plan heavy in fixed income offerings will be heavy in fixed income choices; a plan heavy in equity offerings will be heavy in equity investments.

In 1998, Mr. Rekenthaler pointed out; only large domestic stocks did really well. Checking the Morningstar database I found that foreign stock funds returned 12.81 percent, emerging markets funds lost 26.89 percent, real estate funds lost 15.78 percent, and high yield bond funds lost 0.38 percent. The ironic result: anyone who diversified with small as well as large cap, value as well as growth, international as well as domestic, or who added a dab of real estate--- the kinds of options that sophisticated plans offer--- reduced their return in 1998.

Will such diversification always underperform?

Mr. Rekenthaler doesn't think so. He'll bet that the diversified turtle will look slow against the top asset class in any single year, but will win the long race.

I think that's a good bet. The question is whether 42 million plan participants can learn how to put the right mix together.