A retirement savings plan, such as a 401(k) or 403(b), is a valuable employee retention and recruitment benefit. But sponsoring one takes a great deal of work and employees do not always fully understand the plan’s value or utilize its benefits. Meanwhile, you need to make sure the investment options are sound, diverse, and low cost while meeting participant needs. That means developing an investment policy statement and monitoring process that:
- provides ongoing vigilance,
- regularly reviews participant and fund behavior, and
- considers new investment options.
Modifications to the investment menu may be necessary due to the following factors:
- changes in management team,
- fund or share class availability changes, or
- employee clamor for new selections.
Regardless of the reasons, switching or adding investment options requires careful consideration by plan sponsors.
Analyzing Current Plan Lineup and Use
The first step of considering a new investment option is conducting a comprehensive analysis of current plan participation and asset allocation. Do employees participate and contribute enough to take advantage of your match (assuming there is one)? Are participants broadly on-track to meet their retirement income replacement needs?
Further analysis should focus on the current options used. Are employee investments diversified? How many are concentrated in one non-balanced fund? Are fund fees reasonable compared to others in the asset class? Are more investment options necessary and, if so, in what asset class?
Are any existing funds not meeting the defined expectations? The historical return and risk data of any fund should be reviewed. Look for at least a three-year track record, while ensuring fees are comparable to or lower than others in the same asset class. The study must find whether existing funds should be discontinued or changed for any reason like poor returns, excessive fees, changes in management or style, or lack of usage. The analysis will also illustrate education priorities to help employees take better advantage of new or existing offerings.
New Fund Considerations
You need to ensure your plan has the right asset class mix for your constituency. The complexity of investment options is increasing, while the need to make them understandable and effective for your participants remains important.
There was a trend toward offering dozens of investment options for many years, but research showed that too many choices confused employees. The average 401(k) plan offers 25 investment options, according to December 2014 data from the Investment Company Institute and BrightScope. ERISA, a federal law, only requires three options with materially different risk and return characteristics (not counting target date funds typically offered as the QDIA option).
Many companies rushed to implement self-directed brokerage windows in the 1990s, but only four percent of employees took advantage.
Money market and bond funds are a common choice for diversification, but factors such as low interest rates and inflation make target-date funds a more attractive option. A small but growing number of plans offer alternative investments to an already long list of 401(k) options. It may be tempting (and employees may be asking) to add ETFs, Bitcoin or other cryptocurrencies, commodities, or other specialty options to a mix of core asset classes or index funds.
Specialty funds can provide value in a fully diversified portfolio, but the typical employee needs to understand whatever option becomes available under the plan. Less than one-third of financial advisers understand alternative investments “very well,” according to a survey by Natixis Global Asset Management, and 53 percent believe alternatives are “often too complex to explain.”
Investment Education Needs
The analysis will likely highlight some education goals for the plan, such as periodic rebalancing or promoting diversification. If participation is lower than expected, particularly for those earning less, you may want to boost efforts to educate about saving for retirement.
Additional options can make a plan more complex and drive a need for more education on asset classes, fund return and risk characteristics, diversification, and more. As a fiduciary, you want to make sure every participant receives enough information about the risks of each investment type.
While many employees and plan sponsors may claim to understand investing, it is greatly beneficial to turn to a professional consultant. Your consultant should candidly provide guidance on plan and investment options, and governance.
PlanPILOT is an independent registered investment advisor (RIA), not tied to any funds or investment banks. We help clients control their risks in operating retirement plans and help them deliver the benefits intended. We also review fund lineups and score investments, highlighting any recommended changes.
Read our informative whitepaper on Developing Investment Policy and Structure that could be beneficial if you are considering modifying your investment options. Feel free to contact us if you would like to learn how PlanPILOT can help you.