Five Ways To Make Even Lousy 401(k) Choices Work In Your Favor

In the past several years, retirement plans have been busy adding mutual funds and expanding investment options. But more isn't always better.

"There are still very few 401(k) plans with a lot of investment options we'd enthusiastically recommend," said Paul Merriman, of Merriman Capital Management, a registered investment adviser in Seattle.

So what if you're defined-contribution plan at work features a lineup of mutual funds that seems lackluster?

"I've never run across a 401(k) plan so bad that I would discourage someone from using it completely," said Raymond Benton, a longtime Denver-based adviser. "You should at least be able to find one fund to invest in."

And that's important, as Merriman says, because "you want to take advantage of any matching contributions by your employer," he said.

So rather than compound the problem by making lousy choices within a lousy 401(k) plan, you can make the best of your situation. Here are five suggestions:

1. Use a target-date or life-cycle fund only

Within 401(k) plans, many advisers suggest target-date retirement or life-cycle funds. These include stocks and bonds, both international and U.S. Target-date funds fine-tune portfolio allocations along preset timelines. As you get closer to retirement, they'll gradually reduce stock exposure in favor of bonds.

Life-cycle funds are a bit different. An example is Vanguard LifeStrategy Growth Fund (VASGX) . An investment board sets allocations between stocks and bonds with more aggressive investors in mind. Sister funds are offered aimed at more conservative investors.

"Life-cycle funds stick with more static allocations depending on risk tolerance and investment time horizons," said Valerie Antonioli, another Denver-based adviser. "You've got to actually move out of one fund and into another if you become more conservative or aggressive."

Both types of funds might be best-suited for investors with smaller accounts, she added. "They generally offer fairly basic choices in terms of diversifying a portfolio," Antonioli said.

By automatically leaving allocation and asset class choices up to fund companies, you're also sacrificing an ability to make tweaks as your circumstances change.

Of course, that might not be such a limitation, given that investors tend to make the wrong moves at just the wrong time, points out Antonioli.

"For people with more saved up in their 401 (k) accounts, target-date or life-cycle funds alone probably aren't going to be optimal," she said. "But these types of funds are better options than just putting everything in something like a large-cap value fund or a real estate fund. They're a good place to start."

The popularity of such options means that in all likelihood, some form of one-stop shopping is in your plan. At least 50% of all defined-contribution plans now have either target-date retirement or life-cycle funds, according to the Profit Sharing/401(k) Council of America.

2. Use a balanced fund

The odds improve if your plan has a more traditional umbrella fund. Such so-called balanced funds include stellar long-term performers like Dodge & Cox Balanced Fund (DODBX) and American Funds Income Fund of America (AMECX) .

"Balanced funds of some sort are in almost all plans today," said David Wray, the profit sharing council's president.

But they usually offer less diversification than most target-date and life-cycle funds, says Patrick Geddes, chief investment officer at Aperio Group in Sausalito, Calif.

3. Stick to the index funds

Aperio, which develops and runs portfolios for advisers around the country, suggests that investors consider creating their own simple portfolios using low-cost index mutual funds.

Stock index funds found in some 401(k) plans include Fidelity Spartan Total Market Index Fund (FSTMX) and Vanguard Total International Stock Fund Index (VGTSX) .

"You can really build a good, long-term oriented and well-diversified portfolio with three basic index funds," Geddes said. "One should cover a broad range of top U.S. stocks, the other provide exposure to foreign stocks and a third to bonds."

The same tack can be applied to actively managed funds. Although managers can shift into different corners of the market when cycles change, they're also typically much more expensive than index funds. Actively managed funds are also less transparent than index funds, says Seattle-based adviser Merriman.

4. Get help with your picks

While your own company or plan provider isn't the best place to turn for advice since they are the ones that saddled you with the poor options in the first place, there are outside sources of aid.

For example, Merriman's Web site, FundAdvice.com, contains a 401(k) help section that reviews more than 80 different corporate retirement plans, including U.S. government options. Some of the private companies listed include Microsoft Corp. (MSFT) , Starbucks Corp. (SBUX) , Amazon.com Inc. (AMZN) , General Electric Co. (GE) and Dow Chemical Co. (DOW).

An example is Microsoft. In the most current information on the plan, the site offers three asset allocation models for moderate, conservative or aggressive savers using six to eight of the 18 offerings in the software giant's plan.

Among the holdings used are four active mutual funds. Those are various share classes of ING International Value Fund (NIVAX) , Fidelity Overseas Fund (FOSFX) , Fidelity Intermediate Bond Fund (FTHRX) and Royce Low-Priced Stock Fund (RYLPX) .

The adviser recommends supplementing those choices with a trio of index funds. Those are Vanguard Growth Index Fund (VIGRX) , Vanguard Value Index Fund (VIVAX) and Vanguard Small-Cap Growth Index Fund (VISGX) . There is also a money-market option that figures into the mix of the moderate and conservative portfolios.

The site notes that the plan covers U.S. large-cap and small-cap growth stocks. But it also says that value offerings are light in small-caps, both internationally and domestically. The plan also lacks a dedicated emerging markets fund, say the analysts.

"It's rare we see a perfect plan," said Mark Metcalf, an adviser at the firm. "But most 401(k) plans have at least one good role player you can use as part of a larger diversified portfolio."

Focus on an overall allocation plan and build from there, Metcalf adds. "Look for strong support players instead of a lineup of home-run hitters," he said.

5. Work all your accounts into the mix

And don't forget to include Individual Retirement Accounts and possibly a separate taxable account into the mix, says Bryan Lee, a Plano, Texas-based adviser.

"People have a tendency to focus on their 401(k) plans," he said. "But they can also take advantage of other types of accounts like IRAs."

Says Metcalf: "Pick and choose from the best in each asset class across all of your different accounts, from IRAs to 401(k) plans." That way, even if your 401(k) leaves something to be desired your overall portfolio will still be solid.