If you participate in a 401k, you may own a proprietary fund and not even be aware of it! That’s bad news because these funds are expensive, and typically aren’t the best in class. Having proprietary funds relies mainly on the recommendation from your financial advisor.
What exactly is a proprietary fund?
A proprietary fund is a mutual fund that is owned and managed by your 401k record keeper. As with mutual funds, proprietary funds charge fees for the money management. The amount charged annually goes directly into the brokerage house coffers. Since the managers are internal to the 401k record keeper, the margins are much higher, which means these fees are very profitable endeavors. Also, it’s rare that they outperform outside funds in the same class.
Why do brokerage firms offer proprietary funds?
It’s for the money of course! Every mutual fund charges fees, those annual fees range from 0.15% to as high as 2.5%.
These funds, oftentimes, are the root of hidden fees! They make plans look artificially inexpensive, while charging an exorbitant amount in fees. While we strongly recommend our clients stay away from them as much as possible, it’s good to understand what they are and how they’re used.
Are proprietary funds bad?
There are two major problems with proprietary funds.
- Oftentimes, the record keeper might be given benefits when recommending their own products over others. These benefits can include commissions and higher fees.
- This creates a conflict of interest. On one hand you have a poorer performing fund that shouldn’t be recommended, and on the other hand you have the same fund paying the company more. It becomes very difficult for the record keeper to avoid recommending these funds.
How do you know if you own a proprietary fund?
Look for the name of your record keeper and the manager on funds you own. If you see a match, you’ve got a proprietary fund! That being the case, our suggestion is to ensure it’s the best choice by evaluating your mutual fund, and the alternatives available to you.
Here is a good example of a proprietary fund offered by Principal. The Principal Financial Income Guaranteed Option (PFIGO) fund has very unfavorable terms for clients, yet is regularly recommended by the advisor over the plan. If employees put money into this fund, 80% is locked for 12 months, while PFIGO pays a little over 1% a year. If you as the employer decides to get rid of this fund from the line up, you will be charged a 5% fee on all the money in the fund!
This fund is rarely a good option especially after you compare it to all the high quality funds available on most plans. The advisors still recommend this fund regardless of the significant drawbacks.