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Julie Jason: How is a menu chosen for a company’s 401(k) plan?

March 11, 2018

Have you wondered how your employer chooses the investment menu for your 401(k) plan?

According to the recently released PSCA Annual Survey of Profit Sharing and 401(k) Plans, based on 2016 data, plans offer an average of 19 funds. The funds most commonly offered are indexed domestic equity funds (87.3 percent of plans), actively managed domestic equity funds (85.3 percent of plans), actively managed international equity funds (83.7 percent of plans) and actively managed domestic bond funds (78.8 percent of plans). PSCA, the Plan Sponsor Council of America, is part of the American Retirement Association.

If you were the sole decision-maker standing in the shoes of the employer, where would you start? Would you choose mutual funds that have market-beating performances? Or perhaps funds that employees would recognize by name?

Given that the selecting of funds for your plan carries serious fiduciary responsibility under the law, you need to start with an understanding of what you are trying to achieve for participants. Most importantly, you will be judged on prudence in your selection process. You are not judged based on whether your list outperformed someone else’s.

Considering that you do not want to be changing investment options for employees any more frequently than necessary, your selection criteria need to be sound, evergreen and manageable.

For example, it would not be wise to require a fund to “outperform the S&P 500 by 10 percent” over different periods of time. Once a selection criterion is chosen, you have to live with it. That means that you would have to replace the fund when it did not meet that metric.

So, how do you establish prudence?

Start with what you don’t want. That’s pretty simple. You don’t want funds that you will need to be replacing for underperformance. You don’t want funds that are not a good deal for employees, such as those with penalties or high fees. You don’t want tax-deferred vehicles in your 401(k), such as tax-deferred variable annuities, unless there is a very good reason to justify the higher cost usually associated with double tax deferral.

Various screens for desired characteristics will lead to a good menu. These elements are best incorporated into a written investment policy statement that also serves as a monitoring tool. That is, the funds have to pass the screens on an ongoing basis and need to be replaced when they don’t.

Getting back to returns, a current top performer is not always a good choice. A vocal employee may have fought for a high-performing technology fund or even a leveraged fund. But that might not have fit the fiduciary’s vision of what is best for employees at large. So, while input from employees is always a good thing, participants need to be aware that there is more going on behind the scenes than meets the eye.

That brings up how to get help. Close to 70 percent of plans retain an independent investment adviser to assist with fiduciary responsibilities, separate from the plan’s record-keeper, according to PSCA.

And close to 40 percent of plans surveyed offer a professionally managed alternative. Of those plans that do, the employee bears the cost most of the time (76.4 percent), and the employer pays in 23.6 percent of the time.

Participants need to be able to rely on the fiduciary doing his or her job right. Participants have enough trouble choosing from the menu. They should not be burdened by worries about whether their funds were chosen wisely.

If you would like to discuss the topic of investment selection for 401(k) plans further, please email me with questions at readers@juliejason.com.

Julie Jason, JD, LLM, a personal money manager (Jackson, Grant of Stamford, Conn.) and award-winning author, welcomes your questions/comments (readers@juliejason.com). To hear Julie speak, visit www.juliejason.com/events.