Friday, July 25, 2008

Collective funds instead of mutual funds

Collective funds are like mutual funds, but generally only available in retirement plans (like 401(k) plans), and are increasing in popularity as investment vehicles in 401(k) plans (free WSJ Digg link). The reason that they're replacing traditional mutual funds? They're cheaper.

Just like mutual funds, collective funds pool investors' assets and invest in stocks, bonds and other securities. The chief difference: Collective funds are typically available only in retirement plans. Because they aren't sold directly to the general public, they generally aren't regulated by the Securities and Exchange Commission.

Collective funds tend to be substantially cheaper than mutual funds, largely because they don't have to comply with SEC regulations or market to retail customers. That's driving 401(k) plans to embrace these products, which are offered by big fund providers like Fidelity Investments, Vanguard Group and Charles Schwab Corp. as well as by banks and trust companies.

Only 58% of large defined-contribution plans such as 401(k)s used retail mutual funds in 2007, down from 65% in 2003, according to research and consulting firm Greenwich Associates. By contrast, 39% of such plans used collective funds last year, up from 33% two years earlier. Other common 401(k) investment options include institutional-class mutual funds sold to retirement plans and other large investors, and "separate accounts," which are custom-designed for a single retirement plan.

I checked my 401(k) and sure enough, the funds I'm invested in are collective funds, not mutual funds. In fact, my 401(k) plan offers more collective funds than mutual funds.

Collective fund drawbacks

The Journal story talks about one drawback of collective funds being that they don't have to update their performance frequently, and that their daily prices aren't reported in newspapers. My 401(k) plan publishes daily price changes of the funds on its Web site, so this hasn't been a problem.

Another drawback cited is that collective funds "can't be rolled over to an individual retirement account when the participant leaves the 401(k), so participants have to transfer their funds into other investment options if they take these assets from the plan." However, I don't see this as a big deal since I've never done a direct in-kind rollover from a 401(k) to a rollover IRA when I've left an employer. I've always liquidated the 401(k) holdings and then rolled over.