There’s been much to do in Washington regarding 401(k) plan providers. Recent discussions have centered on whether or not your plan advisor should disclose whether or not they are working in your best interest or their own. In previous blogs I have noted that there’s a lot of misunderstanding about 401(k) plan providers fees and their purpose.
401(k) plan provider investment fee categories
When it comes to investment fees, there are several categories of expense, such as
- The cost of the plan investments,
- The cost of the asset allocation of the investments for participants
- The cost of determining what combination of investment and investment management one should be in.
I liken these functions to the parties to your stomach: grocer, consumer packaged goods company, chef and your cardiologist.
401k plan providers: Grocers
When you go to your grocery store you may see prices of all oils ranging in price from a few dollars to tens of dollars. We often go to grocery stores that have a large selection. That usually helps us feel that we can benefit from lots of choices. The grocery store does not provide any kind of guarantee or warranty on what they’re selling. In fact in some cases some of the products on their shelves actually paid a fee to the grocer in order to get in front of you the consumer. The platform provider sometimes known as the recordkeeper, can be seen in the light of being a grocer. You may pay them directly or have a portion of the fees that may have gone to investments offset their costs. This actually may be happening without your actual knowledge. You pick your investment menu from what this recordkeeper has available on their “shelves”. Just like a grocery store, all of the recordkeeper is to not have all of the same investments available which limits your choice for your employees.
401k plan providers: Consumer packaged goods company
Have you noticed that there are few advertisements for recipes and cookbooks? In fact usually when we see advertisements for recipes there often done by the companies that make the ingredients for the recipe. Interestingly enough you may find recipes on the side of one of your consumer package goods. While they seem to highlight the necessary use of their own product they typically show the generic version of the other ingredients for that recipe. These consumer package goods companies are analogous to some of the well-known brand investment companies who make investments designed to be used in 401(k), 403(b) and other retirement plans. It’s often the investment company that a fiduciary bases their selection of recordkeeper on. These well-known brand names give some people the sense of safety. As a fiduciary, you may find the opposite is true. Investments are packaged for use in retirement plans. The same name does not indicate the same cost structure. For example, one may have a fee of 2% versus 1%. That means that the investment has been diluted by 1 percentage point. This difference has been attributed to a reduction in future balance by 17%1.
401k plan providers: Chefs
There are cooks and chefs. I use the term chef for people that have actually graduated from culinary school. Most chefs pick their own ingredients. In fact that helps eating out more attractive. I’ve learned from a few chefs that they often don’t use the most expensive ingredients when making their dishes. Their experience tells them that some ingredients aren’t worth the additional expense for a higher quality ingredient.
After taking a few cooking classes, I learned that trained chefs use the least expensive oils for cooking and reserve the more expensive oils for finishing the dish. One of the oils purpose is cooking and the other is to create taste. While some home chefs could afford the most expensive olive oils likely they would not tastes any difference in flavor for what they’ve expended.
An ERISA 3(38) investment manager is a fiduciary chef. Some investment managers are just trying to create the one best investment in a particular category, while others are trying to put the diverse mixture of investments into a portfolio design for specific risk and return characteristics. I believe that most people are best served by finding an investment manager the puts together a model portfolio. When they’re doing so they should be trying to find the best combination of ingredients that work together no matter what the market is like based on level of risk. A famous investment study done by Beebower2 and others attribute investment success to the allocation of investments, which is the job of the investment manager. Asset allocation does not ensure a profit or protect against a loss.
Adding confusion is the use of professionally managed portfolios often referred to as qualified default investment alternatives. Rather than simply create the investment ingredient, they have now pre-packaged them in an all-in-one portfolio. Unfortunately for you they are not officially taking on the risk that an ERISA 3(38) investment manager solely hired to create portfolios takes on. You are left with a new risk of evaluating their portfolio on top of the investment ingredient.
Participant focused retirement plan advisor as cardiologist
Your participants may need a retirement plan advisor focused on them to act as a cardiologist. The job of this person is to help your employees figure out what’s right for them. That means that this advisor must take on fiduciary responsibility for their advice. While not imperative, I believe they should have advanced planning credentials such as Chartered Retirement Planning Counselor, certified financial planner professional. While these designees take an oath to work in their client’s best interest, make sure that their contract says they are working as an investment fiduciary.
If you’re like many fiduciaries you might find this a bit overwhelming. I recommend finding a retirement plan advisor that will act in a fiduciary capacity for you the employer. After vetting this fiduciary ERISA 3(21) advisor you will now have someone with investment fiduciary knowledge sitting on the same side of the table as you. They can help you understand what types of 401k plan providers you and help to determine if their cost is reasonable given the services they are providing. You may find some fat in the pricing that you can cut out and reallocate to provide a participant focused retirement plan advisor. You could contact us.
- United States Government Accountability Office, PRIVATE PENSIONS Changes Needed to Provide 401(k) Plan Participants and the Department of Labor Better Information on Fees, November 2006
- Gary P. Brinson, Brian D. Singer and Gilbert L. Beebower, “Determinants of Portfolio Performance II, An Update,” Financial Analysts Journal, May-June 1991.
- This material was created for educational and informational purposes only and is not intended as ERISA, tax, legal or investment advice. The advisor is providing educational services only and is not able to provide participants with investment advice specific to their particular needs. If you are seeking investment advice specific to your needs, such advice services must be obtained on your own separate from this educational material