Most people with 401(k) plans are thankful to have a retirement fund at all these days, considering the crazy job market. And for those folks intimidated by Wall Street and uncomfortable managing their retirement solo, the mutual funds offered via your employer might seem like a great way to get some peace of mind.
Not so fast. The problem is that even professional mutual fund managers often screw up, and a mistake in your 401(k) plan can sometimes be as painful as mistakes you would have made actively managing your own money.
And in this crazy market in the wake of the financial crisis, it only takes one bonehead decision to kill your 401(k).
Consider the performance of Bill Gross, widely regarded as the smartest bond investors and on the planet. His PIMCO Total Return Fund (MUTF:PTTRX) boasts almost $250 billion — yes, billion with a “B” — in assets under management. Unfortunately, Mr. Gross made a notoriously bad call at the beginning of 2011 and at his worst had lost investors more than 10% while the broader stock market was basically flat.
That’s not to say this fund is now dead money. It actually has bounced back fairly nicely in recent months. But the lesson should be clear: If it can happen to PIMCO’s Bill Gross, it can happen to any mutual fund manager. That means you can’t just fly blind and trust that your money will be taken care of.
I have identified five funds to watch out for as big risks in 2012. These specific picks could kill your 401(k), but they also tell important stories about different asset classes and fund “flavors.” So don’t think that just because you’re not holding these five particular mutual funds that you’re in the clear.
T. Rowe Long-Term U.S. Treasury
In the past 12 months, the T. Rowe Price U.S. Treasury Long-Term Fund (MUTF:PRULX) has soared more than 20% — so you might think it’s a great bet for 2012 and beyond. But hold your horses. There’s a reason for the Wall Street cliché that “past performance doesn’t guarantee future returns.”
Long-term Treasury bonds are the safe haven for skittish investors, and there were plenty of reasons to scare off traders in 2011. The short list of news prompting a flight to safety included a downgrade of the U.S. credit rating, geopolitical unrest in the Mideast, Japan’s tsunami and the eurozone debt crisis. That’s on top of persistently high unemployment in America.
However, signs of stability are emerging that might draw investors back into riskier investments like stocks in 2012. That could move money out of bonds.
Many investors also fail to realize that it’s possible for a bond to lose value, as evidenced during the 2008 credit freeze. Treasury bonds generally are a good place to park money, but they will do little to help you grow it. Rock-bottom interest on these bonds thanks to Federal Reserve policies to keep rates near zero means it’s not going to take much to prompt investors to start looking somewhere else to make a better return.
In short, long-term Treasuries aren’t ideal investments for anyone looking to retire years down the road because the outperformance of this asset class will soon screech to a halt. T. Rowe’s fund is a bad idea — but, then, so are all long-term U.S. Treasury funds right now.
Dreyfus Greater China
The casual 401(k) investor might think that amid global economic slowdown, China remains the one red-hot market. After all, China GDP is running at about a 9% annual pace — significantly higher than America and Europe — and Western companies from McDonald’s (NYSE:MCD) to General Motors (NYSE:GM) are all betting big on the boom of China’s emerging middle class.
So how come the Dreyfus Greater China Fund (MUTF:DPCAX) is off more than 30% in the past year? And why is it that other emerging-market funds with a China emphasis also have flopped so badly?
To use the Wall Street phrase, it’s because of fears about a “hard landing” in China. There are worries about what will happen to the export giant if its currency continues to strengthen, and if America continues to talk tough about trade. There are hints of a housing bubble in China, with reports of high-rise ghost towns with no residential tenants in the condos and no businesses in the office space. Then there’s the concern about any data we are given from the communist state, since China is notoriously opaque.
The bottom line is that it is extremely difficult to transition from a hyper-growth emerging market to a slower-growth developed economy, and there are countless examples of this. Many fear China will be hitting its wall soon after years of rapid expansion — and if the end doesn’t come in 2012, it will come in the next few years for sure.
That makes Dreyfus Greater China and all other China-focused funds a very risky bet for your retirement. The growth was good while it was there, but the decline in China could be a 401(k)-killer.
Vanguard Diversified Equity
Vanguard Diversified Equity (MUTF:VDEQX) has a great name. You’d think that by buying into this fund you are getting a well-balanced portfolio meant to mitigate your risk. Unfortunately, it’s diversified in the worst way possible.
This Vanguard investment is a so-called “fund of funds.” That means its holdings are other mutual funds — eight of them, to be precise. Why is that bad? Well, because you are paying fees twice — once to Vanguard for Diversified Equity, which then pays fees to the other funds within its stable.
On top of that, the diversification is not achieved through calculation but by a “too many cooks in the kitchen” approach. As of this writing, Pfizer (NYSE:PFE) or Apple (NASDAQ:AAPL) pop up in most of the eight component funds’ list of top holdings. Why the heck do you need that many mutual funds to comprise VDEQX if they’re going to own the same stocks?
Even more damning is that the collective fund managers aren’t exactly the cream of Vanguard’s crop. InvestorPlace.com mutual fund expert Dan Wiener writes that “Diversified Equity’s eight-fund portfolio has almost 20 management teams, and none of them is on the short list of funds to build your portfolio from.”
No wonder Vanguard Diversified Equity has underperformed the market significantly in both short- and long-term returns.
In general, “funds of funds” are pretty suspect investments. But Vanguard Diversified Equity is a prime example of the problems presented by this kind of fund and how it could kill your 401(k).
Fidelity Select Automotive
Sure, you might think I’m crazy calling out Fidelity Select Automotive (MUTF:FSAVX) as a pick that will kill your 401(k) in 2012. But here’s the bottom line: If you are a 401(k) investor building a broad-based portfolio, it’s unlikely that such a focused sector bet — in this case, on autos — is in your best interest.
Why? Because conditions that make these picks soar quickly can also make them drop like a rock. Case in point: Fidelity Select Automotive suffered an ugly 30% drop across all of 2011.You should never expose your retirement funds to that kind of volatility.
Let’s say though, for the sake of argument, that you’re a savvy investor who wants to bet big on the auto industry and aren’t looking to play it safe. Why would you pay a fund manager to make that bet with a mutual fund when you can cut out management fees and make it yourself? Fidelity Select Automotive has a 0.91% expense ratio, meaning almost 1% is shaved off your returns and pocketed by the managers. Why not just buy individual automaker stocks including General Motors or parts company Johnson Controls (NYSE:JCI) independently? The top 10 holdings of Select Auto make up about two-thirds of the entire portfolio — so it’s not like the fund provides that much more diversification.
If you’re a long-term investor eying retirement, Fidelity Select funds — and focused sector funds of all stripes — probably are a bad bet. They aren’t diversified, expose you to too much volatility and charge rather high expenses to manage your money.
If it’s risky to make big sector plays with your 401(k), it’s downright silly to plow a significant portion of your investments into gold right now. The precious metal is very attractive in an unstable economic environment, but anyone with access to the Internet can find out the boom-and-bust cycle of gold with just a few mouse clicks.
The boom is what all the people on “cash for gold” commercials want you to hear. True, gold has never gone to zero … but gold did drop 65% in just two years across the mid-1980s. And while gold is seemingly a great hedge on inflation because it tends to rise over time, keep in mind that to grow your nest egg, that gold needs to not just keep pace with inflation, but outpace it.
Gold is an investment like most others, with risk and potential. And while gold is a good buy at certain times, it might be nearing a top right now. Consider that the Oppenheimer Gold & Special Minerals Fund (MUTF:OPGSX) fund dropped more than 25% in 2011 — while charging investors a very hefty 1.89% expense ratio on top of that.
You have to count on a heck of a return to outpace inflation and offset those fees. The Oppenheimer fund clearly failed miserably.
Investors should steer clear of this fund, and think long and hard about any other precious metals investment for their 401(k). The returns might have been nice in previous years, but going forward there’s a chance that gold funds could really damage your nest egg.
Jeff Reeves is the editor of InvestorPlace.com. Write him at editor@investorplace??.com, follow him on Twitter via @JeffReevesIP and become a fan of InvestorPlace on Facebook. Jeff Reeves holds a position in Alcoa, but no other publicly traded stocks.