The most important issue to keep in mind is that the 401(k) plan is established for the benefit of the plan’s participants. Selecting an investment solution must be done in a prudent manner with the same skill and diligence that would be expected from an expert. In fact, ERISA (Employee Retirement Income Security Income Act) holds plan sponsors and trustees to the prudent expert rule. While there may be differences of opinion among experts on investment strategies, a couple of key points are universal.
- Expenses reduce investment performance;
- Seldom are active managers able to achieve the benchmark returns they are measured against.
For the past ten years there has been an escalation in the number of lawsuits brought against plan sponsors and trustees over poor performance and fees. As the market continues to languish in mediocrity this trend is expected to continue. So what is a plan sponsor to do?
The challenge plan sponsors face in determining an appropriate investment solution for their firm’s 401(k) plan is to set aside their own personal convictions and investment philosophies for the moment. Strategies such as market timing, investment selection and sector rotation may add perceived value but there is no academic research to support them as a prudent long-term approach. Furthermore, a plan sponsor relying on advice from a financial advisor may be engaging someone with a conflict of interest to the plan.
A conflict of interest can arise when a financial advisor is “hired” to provide services for the plan and is compensated based on the investments recommended to the plan. It has been our observation that plan sponsors hire advisors without requiring them to sign on as an ERISA Section 3(38) fiduciary. Under this section of ERISA the plan sponsor is relieved of their fiduciary responsibility for selecting and monitoring the plan’s investment options. The plan sponsor is, however, responsible for monitoring the advisor.
Best Practice
- Include a broad away of low cost index funds;
- Hire an advisor who will sign on as an ERISA Section 3(38) fiduciary who will develop investment models using the low cost index funds.