Are your 401k investments helping or hurting your employee’s chances for a secure retirement? Are your plan’s investment results better than the average plan’s results that I have seen which fail to beat the S & P 500?
Too many 401k investments
You are responsible for deciding what 401k investments go into your 401k. You are only required to have 3 investments. If you have more than that, why do you? Recently, I spoke with a CFO that shared his menu was selected because it includes at least one stock (equity) choice from each of Morningstar’s style boxes. Morningstar developed that system to help analyze the different styles of stock investments that a given investment may fall into. Those who believe in asset allocation might use investments in several of the categories to develop their portfolios. Do the employees know that is why there is so many investment choices? Do they have the tools and knowledge to build “modern portfolios”?
The Employee Retirement Income Security Act only requires three investments- a stock, a bond and cash. As the majority of stock and bond investors fail to beat the benchmarks, the majority of employees would be better off simply pick the least expensive Stock and Bond equivalents in the proportions that fit their risk/return investment needs retirement.
Poor monitoring of the 401k investments
You likely don’t get paid to monitor the menu. Some sponsors think that is what the provider is paid to do. Some think that it is a voluntary program- the employees can take it or leave it. Unfortunately, the law says that you are responsible for making sure that the options are good. While the law points to risk/return, most sponsors and employees look at gross return. However, it is not common that they consider gross return against benchmarks, such as the S & P 500, Russell 3000 or Barclays Capital U.S. 5-10 Year Government/Credit Float Adjusted Index.
No employee education on the retirement investment menu
One of my private wealth clients said that her employer’s chosen recordkeeping provider didn’t educate her on her options. I spoke with a representative of the recordkeeper and they said that it was the responsibility of her employer. Enough already.
It is clear that without education few of us would get good results on anything, much less the investments that will help us create the retirement income we will need to live on. Do you provide an annual education program or in-plan advice?
Failing the 404(c) safe harbor for employee 401k investments
The law allows you a safe harbor against the chance that employees make bad choices and try to blame you. I have found many firms select this protection on their annual tax filing (5500) but do nothing in particular to qualify. As this is optional, some industry practitioners believe it is harmful to say that you intended to comply and did not. One of the keys to the safe harbor is employee education. The high road would be to have an annual meeting to explain the choices and changes to the employees. This way they could ask questions of the educator.
Not monitoring employee investment results
Even if your investment menu was five stars, what good is it if the employees get 1 star results? What good is a Morningstar 5 star menu if your employees get 1 star results? By the way, Morningstar wrote that a low expense ratio is a better predictor of future investment success. Knowing how well your employees are doing should be a great guide in evaluating the first 3 traps.
How are you dealing with these traps? I welcome your email comments james.brewer@lpl.com. Because of spam and regulator issues, I have disabled the comment section.
(1) The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. (2) Securities and Advisory services offered through LPL Financial, a Registered Investment Advisor. Member FINRA/SIPC. (3) The LPL Financial Registered Representatives associated with this site may only discuss and/or transact securities business with residents of the following states: AZ, IN, IL, MI.
