I think investment allocation should be thought of like team chemistry. You often hear coaches talking about team chemistry. The idea being that the team members somehow came together and became better than themselves individual. Basketball’s San Antonio Spurs are the perfect example. They don’t make it on ESPN’s Top Ten Plays and have no mention of the league’s Most Valuable Player. However, they continue to have the top won loss record in the league.
You may have heard that there is no I in Team. In fact there are 13 that came together and formed the word. Assembled in the right order that spells team assembled in the wrong order it spells MEAT.
Investment allocation- it’s the formula
When assembling an investment menu for your employees, you need to think of how the investments can be assembled to create a balanced investment allocation. ERISA states that the investment menu be developed to avoid “large losses”. ERISA requires that you have three investment choices that have different risk and return characteristics. Investment allocations is most often called asset allocation. Mixing different types of asset classes in varying percentages will create different types of results. Asset allocation along with the efficient frontier is at the foundation of ERISA’s investment requirements. This will allow participants to create the investment allocation that is right for them.
Your plan may have 20 or more investment choices. Quantity of investments does not necessarily mean that your options meet ERISA’s diversification standard to avoid “large losses”. The number of investments does not minimize large losses, especially if the choices are Large Cap Investments. Adding more of the same asset class, in this case Large Cap, will further concentrate rather than diversify the portfolio.
Outsourcing the investment allocation
There are investments that already combine assets of different classes into one investment allocation. These can be based on a certain risk level. This gives participants the benefit of professionally done diversification. You can choose options that use passive strategies and some that use active strategies. You can also pick socially responsible investments incorporating Environment Social and Governance screens. You, the fiduciary, can get the safe harbor of a qualified default investment alternative.
You can significantly reduce your liability and save time monitoring these investments by hiring an ERISA 3(38) investment manager. This type of financial pro handles the selection, managing and monitoring of your investments. If you get audited or sued, they are the ones that will be on the hot seat to explain the investment choices not you.
Some ERISA 3(38) investment managers put their seal on other’s investment allocations and some create their own. You can hire an ERISA 3(21) investment advisor like us to help you navigate your choices.
Investment allocation and other people’s money
As a fiduciary, it’s important to explain to your employees the reasons behind your investments and provider selections. It is well documented that investment performance is more about the investment allocation and not the investments (remember the San Antonio Spurs). You also have a Duty of Loyalty to help your employees. If your employees are not investment professionals with credentials like Chartered Financial Analyst, CERTIFIED FINANCIAL PLANNER™, Ph. D or MBA they need help with investment allocations. This simplifies their decision making down to risk level and not selecting Investments and managing them to work as a diversified TEAM.
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