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By BRETT ARENDS

Chances are you have a 401(k) plan at work. And the chances are you’re not making nearly enough of it. A new year means a new leaf: This is as good a time as any to start turning that around.

If you’re letting your 401(k) languish, a report released over the holiday season shows that you’re not alone. According to the latest study by the Employee Benefits Research Institute, a think tank in Washington, most of us continue to neglect our 401(k) plan. The median account contains a balance of just $18,000, says EBRI.

Good luck with that.

Here’s a five-step plan to fix your 401(k).

1 Take control.

Take a look at the full range of investment choices available to you. That should include, at a minimum, a handful of low-cost domestic and international stock and bond funds. If your plan doesn’t even offer those you should talk to the people in charge at your employer and insist that they move to a better plan.

Many people are too intimidated, or busy, to choose their portfolio. If you’re in that camp, your plan will have dumped your money into a default portfolio—such as a low-yielding but “stable” fund, or a target-date fund ostensibly designed for someone of your age.

There is nothing inherently wrong with these funds. But that doesn’t mean you can rely on them, either.

These default options aren’t designed for your best interests, but for the best interests of your plan provider. Instead of maximizing your likely returns, they are designed to minimize the provider’s risk of a nasty lawsuit.

As a result, your money may well be sitting in a poorly designed portfolio that guarantees mediocre performance. Target-date funds, for example, are a great idea in theory. In practice, most are far too heavily weighted toward U.S. stocks, and they use a cookie-cutter approach to investing.

Consider the alternatives available to you.

You also should understand if your company makes matching contributions, and, if so, how much it will match. There’s no good reason for missing out on a company match. It’s also a good idea to find out if your plan allows such things as personal loans: This may offer you access to cheaper capital than a bank, although there are risks in borrowing from your plan.

2 Cut your costs.

Many 401(k) plan providers stock their plans with high-fee mutual funds. That’s great for them, and bad for you. Most mutual funds are far too mediocre to justify hefty fees, which just soak up a lot of your investment returns. A fund that charges you an extra 1% a year may end up costing you most of the tax benefits of your plan.

There are managed investment funds out there that are worth the money, but few of them—if any—are likely to find their way into a 401(k) plan. If you’re stuck with plain-vanilla funds, you are going to be better off going for the ones with the lowest costs. Nearly all the time your best options will be the low-cost index funds.

3 Lighten up on U.S. stocks.

Most people keep most of their stock-market investments in the U.S. It’s safer, right? I mean, it’s the home market so it’s less risky than foreign stocks, yes?

That’s what conventional wisdom says, but it’s hooey. Investors sell themselves short by investing too much in the U.S.A. You’re already overinvested here anyway—you have your life and career here.

And U.S. equities start 2012 looking relatively expensive. U.S. stocks today are somewhere between modestly and heavily overpriced when compared to such metrics as average earnings or the value of corporate assets, according to data from the Federal Reserve and data tracked by Yale University economics professor Robert Shiller.

The dividend yield on the Standard & Poor’s 500-stock index, at just 2.1%, is very low by historical standards.

Predicting future stock-market returns is notoriously difficult. But based on current valuations, the U.S. stock market seems to offer a mediocre bet.

4 Look internationally.

Many 401(k) plans go light on international investment options. The real reason is simply the incompetence and complacency of plan sponsors.

But if your plan offers international options, take advantage. The turmoil of 2011 has left many overseas stock markets looking like a good value.

Western European markets fell nearly 30% from last year’s peak. Japan’s Nikkei 225 index is now lower than it was during the tsunami panic nearly a year ago. Emerging markets from Brazil to India, the investment hotshots of 2010, have dropped dramatically out of fashion again. Their stock markets crashed last year.

These offer some excellent buying opportunities.

Emerging markets account for about a third of the world economy, and their share is growing. Developed overseas markets, meaning Europe, Japan and Australasia, account for about two-fifths. They are on sale, and most people are underinvested there.

5 Review your bond funds.

As a general rule, your 401(k) and other tax shelters are where to hold the bond portion of your portfolio. That’s because bonds are much more vulnerable to taxes than stocks.

Bonds generate most of their returns through coupons, and those are usually taxed at ordinary-income tax rates. By contrast, stock dividends and capital gains generally get taxed more lightly.

Right now is, admittedly, a risky time to invest in U.S. bonds. Yields on U.S. Treasurys have slumped to historic lows. Any pickup in the economy, and inflation, could send bond funds tumbling.

While Treasury bonds offer meager yields here, look at any corporate bond funds. That includes investment-grade bonds and more volatile high-yield bonds.Both offer somewhat better yields. Emerging-markets bonds offer particularly good opportunities, argues investment guru Rob Arnott, chairman of Research Affiliates. They pay higher interest rates than those in the U.S., while their governments’ finances are actually in better shape.

It’s crazy that most 401(k) plans offer such a limited range of investment options. Paradoxically you don’t get full control of your money unless you leave your employer, when you can roll the plan over into a self-directed individual retirement account. But your 401(k) still represents a great investment asset, and this is a good time to get it into shape.

Write to Brett Arends at brett.arends@wsj.com

Send your prediction to
crystalball@wsj.com
by midnight EST Sunday, with your full name, city, state and phone number. The first reader who gets it right will be named in next Saturday’s paper.

On Thursday, retailer Sears Holdings will unveil fourth-quarter earnings. This year, the company’s stock has returned an astounding 66%. What will the share price be at the market close on Thursday?

Congratulations to Omar Darr of Whitefish Bay, Wis., for coming closest to guessing Zynga‘s revenue of $311 million in the fourth quarter.

Sixty federal tax provisions expired in 2011, but one stands out for causing older taxpayers trouble: the individual-retirement-account donation rule.

This popular provision allows IRA owners 70½ and older to contribute up to $100,000 of IRA assets directly to a tax-free charity. Such donations aren’t tax-deductible, but neither do they count as income that might trigger higher taxes on Social Security payments or higher Medicare premiums. Now this benefit is gone, at least until Congress restores it.

Greg Clarke

“It didn’t have to be this way,” says George DeBaker, an 83-year-old retired education administrator living in Fort Myers, Fla. In the past Mr. DeBaker gave his entire five-figure required IRA withdrawal directly to several church-related charities; he would like to do so again this year but is waiting for lawmakers to reauthorize the law for 2012.

“I wish Congress would get its act together, because this is very frustrating,” adds George Papadopoulos, Mr. DeBaker’s financial planner in Novi, Mich., echoing the sentiments of many others.

No fix is in sight, although many experts think lawmakers will act eventually. In 2010, the law also expired, and Congress didn’t re-enact it until mid-December of that year. The fix was retroactive to the beginning of the year.

But many would-be donors lost out due to a quirk in the law that could snare people this year, too, says IRA expert Natalie Choate, an attorney with Nutter, McClennan & Fish in Boston.

The problem arises for IRA owners like Mr. DeBaker, because they are over 70½ and must take an annual payout from the account. They want to withdraw as little as possible in order to let the assets expand but also want to donate some or all of the required payout directly to charity.

Under current rules, the first dollars out of an IRA count as the required withdrawal. So if an IRA owner makes a withdrawal before Congress extends the law, he or she can’t redeposit the funds and make a donation of IRA funds after lawmakers act.

Here is Ms. Choate’s advice for handling this dilemma. Donors who know they want to make a donation should go ahead and have the sponsor transfer IRA assets directly to the charity. Assuming Congress makes a retroactive fix, the gift will count as a qualified donation of IRA proceeds.

“If you intend to make a gift no matter what, don’t get all stressed waiting for Congress,” she says. “Ideally they will bless that gift, as they did in 2006, 2009 and 2010. The worst that happens is that you’ll have a taxable IRA payout and a deductible charitable gift.” These may cancel each other out for taxpayers who itemize, leaving no tax burden.

Donors who want to make a gift only if they can do it with IRA assets should be careful to “leave room” for the donation when taking payouts.

Here is an example: Jane’s required IRA payout is $30,000 this year, and she doesn’t want to withdraw more. She wants to give $5,000 of the IRA to her college if she can, but if she can’t she wants to contribute appreciated stock or cash.

In this case, Ms. Choate says, Jane should withdraw no more than $25,000 before Congress acts, in order to leave room for the donation. That is because if Jane withdraws the full $30,000, and Congress reinstates the law, she can’t later reclassify part of it as a donation to the college.

IRA donors who plan to make 2012 gifts should keep in mind other legal requirements, says Conrad Teitell, an attorney at Cummings & Lockwood in Stamford, Conn.

The assets must be transferred directly from the sponsor to a qualified charity, and the gift must be received by year-end. The benefits aren’t available for IRA transfers to most private foundations and donor-advised funds.

—Email: taxreport@wsj.com

By KELLY K. SPORS

It’s a common scenario: Someone walks into a chain restaurant, loves the food and ambiance and suddenly thinks, “I should own one of these.”

It’s tempting to pick a franchise based on personal experiences or love of the product. But the fact that you’re smitten with the business or what it sells doesn’t mean it fits your lifestyle, financial situation or long-term goals.

Franchise buyers need to spend ample time exploring their options and doing some thoughtful self-exploration before signing on the dotted line. The last thing you want is to buy a fast-food restaurant only to realize you don’t like 80-hour workweeks, chatting up customers or managing 20 people.

Many people buy franchises “thinking about how much money they can make without thinking about lifestyle issues,” says Mark Siebert, president of iFranchise Group, a Homewood, Ill., consultant to franchisers.

Self Exploration

Of course, a franchise’s financial health is an important factor and franchisees must spend ample time investigating a system. But along with that due diligence, they also need to think about their own skills, lifestyle preferences and long-term goals.

This means answering questions like:

• What are my biggest strengths and weaknesses both professionally and personally?
• How much money can I afford to invest in a franchise without risking all my retirement funds?
• How much flexibility do I want in the hours I work? What’s my risk tolerance?
• What tasks will I be happy spending at least 30 hours a week doing? What are my long-term goals?

For instance, many people assume they want a food-based franchise because they ate at one that they really enjoyed. But restaurant franchises often require huge upfront costs, lots of workers and inflexible long hours. Some people thrive in such an environment, but many people want a franchise with more flexibility and fewer employees.

Many people don’t realize the wide variety of franchises out there until they start looking, Mr. Siebert says. Nowadays, there are franchises for just about every industry imaginable with very different business models.

Some allow franchisees to set their own schedules and work from home. Some are far less flexible and require hiring and managing a lot of people; others are geared toward solo entrepreneurs. Some franchises require someone to be good at sales while others might fit less-brazen personalities.

Outside Opinions

Les Jordan, of Webb City, Mo., and his wife, Dian, purchased a Caring Transitions franchise last year. Mr. Jordan, 61, chose the franchise — which helps families sort through belongings and organize estate sales — after looking at dozens of other options.

Mr. Jordan had considered fast-food chains, home-design businesses, and woodworking suppliers among other options. But he ultimately chose Cincinnati-based Caring Transitions because he liked the low start-up costs as well as the ability to run the business from home and to mostly set his own hours. Having spent 25 years working for an architectural and management company, he also felt his previous sales experience would help.

“I didn’t want something where I’d have to come into work and do the same things day in and day out,” Mr. Jordan says. “That’s what I’d done for so much of my career — I wanted something different.”

Conducting such in-depth personal analysis is often easier said than done. People aren’t always the best judges of their own character. So, prospective franchisees should consider seeking some outside help assessing their strengths and weaknesses.

Friends, family members, former colleagues and objective advisers can give prospects some helpful insights on their personalities and strengths.

Getty Images

There also are so-called franchise brokers, professionals who interview prospective franchisees and then provide them with a list of compatible franchises for free. They could help a person clarify personality strengths and goals and provide a greater level of detail about the franchise systems and what franchisees are expected to do.

But there are limitations to using a broker. Many represent only a sliver of all the available franchises, and they get paid a hefty commission from the franchiser when a person buys one of the recommended franchises.

Finding the One

Once a prospective franchisee has come up with a list of criteria, there are some resources to help narrow down the pool of 3,000-plus franchises out there.

The International Franchise Association’s Web site, franchise.org, offers a free, searchable database of more than 1,250 franchise systems. On the home page, scroll over the “Find Your Franchise Here” tab near the top left, and then click on “Search over 1,250 Franchises” underneath it.

Some companies publish franchise directories that offer details about the franchise systems and what franchisees will be expected to do.

Also, Source Book Publications’ franchise directories provide detailed descriptions of the franchise systems and how they operate, including capital requirements, royalties and staffing needs. The publisher’s Bond’s Franchise Guide, 2008 (19th) Edition costs $34.95 online at SourceBookPublications.com.

• Kelly Spors covers small business for The Wall Street Journal. Email: kelly.spors@wsj.com

Fund Scope | Scoreboard

A recent court case against Fidelity Investments is interesting, but not for the reasons you might expect.

Ten days ago, Fidelity won its appeal in a whistle-blower case. Two Fidelity employees had claimed, in separate lawsuits, that the firm had retaliated against them for pointing out what they saw as accounting problems with its mutual funds. The U.S. Court of Appeals ruled that because Fidelity Investments was not the same legal entity as its funds—it had a contract relationship with them—the two employees were not protected by the Sarbanes-Oxley whistle-blower provisions.

Those protections cover only employees at public companies, and Fidelity is privately held. Newer and broader whistle-blower protections were made part of Dodd-Frank legislation. The Securities and Exchange Commission and the Department of Labor both filed briefs supporting the former employees. The SEC says it is reviewing the decision.

“I’m not surprised the SEC filed an amicus brief,” says Barry Barbash, partner and head of the asset-management group for law firm Willkie Farr & Gallagher. Barbash also served as the SEC’s director of investment management from 1993 to 1998. “The SEC wants to be supportive of whistle-blower functions and would support a broader reading. It recognizes its shortcomings in terms of resources. The court paid no deference to the SEC opinion, but it’s on record.”

Fidelity wouldn’t discuss the case except to say the employee claims had “no merit” and that it has long provided staff with a hotline to report anonymously “potential violations of ethical business practices, laws or regulations.”

But these events happened years ago, and the larger issue here isn’t one of whistle-blowing. It’s the bright legal line the courts are drawing between mutual funds and the companies most investors think they are a part of. Last summer’s Supreme Court decision for Janus was even more startling in this respect. In June, the court ruled in favor of Janus Capital Group (ticker: JNS), effectively saying the parent company wasn’t responsible for misstatements in Janus fund prospectuses, and stockholders of the publicly traded firm weren’t allowed to sue.

In this case as well, the funds were deemed separate legal entities, and neither the parent company nor the subsidiary, Janus Capital Management, were responsible for claims made in multiple prospectuses that the funds had taken steps to prevent market timing, the practice of allowing some institutional customers to rapidly trade a fund at the expense of longer-term shareholders. Janus stockholders said those assurances were assumed to be false when, in 2003, New York’s attorney general filed a complaint against the company, causing its share price to fall. Janus Capital Group agreed to pay $201 million and cut fees by $125 million to settle claims by state and federal regulators, causing a further drop in its stock. But Janus Capital Group stockholders weren’t allowed to sue for losses because, according to the Supreme Court, Janus Capital Group was not responsible for the promises made in Janus funds’ prospectuses.

THESE LEGAL BATTLES SHOULD BE a reminder for investors. While the courts insist the funds are separate legal entities, investors rarely acknowledge that fact. “It would be a distinction without a difference but for the fact the courts have drawn a very sharp distinction,” says Neil Getnick, managing partner at New York law firm Getnick & Getnick. “Now shareholder rights are at issue.”

The problem with this construct, Getnick says, is that it’s a “legal fiction”—a description that came up more than once in conversations on this topic. “It implies the mutual fund is a wholly distinct entity with a separate advisor, when in reality it functions as one unit,” he says.

This raises the question of fund boards. Every mutual fund is required to have a board of directors that meets, in person, at least four times a year. The primary role of fund boards is to negotiate fund fees on behalf of fund shareholders, and keep watch for any potential conflicts of interest at the fund-advisor level, says Susan Ferris Wyderko, president and CEO of the Mutual Fund Directors Forum. The majority of fund boards are made up of so-called independent directors, which means they do not have “any significant business relationship with a mutual fund’s advisor or underwriter.” Many independent directors serve on multiple boards.

Do these boards do enough? “Independent directors play a minority role in most cases,” Getnick says. “They may see something, but that’s putting a lot of responsibility on them.”

What’s more: “The courts have not been that tough on fund boards, either,” says Laura Lutton, editorial director for Morningstar. “Most litigation around fund boards is fee-related. It raises the question as to whether the boards are a good enough watchdog for shareholders.”

But that question we’ll save for another column. 

Money Funds Suffer

Equity funds averaged $5.4 billion in weekly inflows in the four weeks ending Wednesday, according to Lipper. Taxable-bond funds averaged inflows of $7.7 billion and municipal funds $1.2 billion. Money-fund outflows averaged $11.5 billion.

E-mail:
beverly.goodman@barrons.com