401(k) participants need help. Advisors who care about the individual participant are in a great position to help them reach their retirement goals.
However, despite the good intentions of advisors, far too many 401(k) plans are underperforming. Here are some ways advisors can turn that tide:
Encourage higher contribution rates
Perform better fund selection
Promote the use of Target Date funds
Perform an annual fiduciary plan review
Encourage higher contribution rates. The 401(k) plan is an excellent vehicle for employees to save money for retirement. Unfortunately, participants still do not accept nor understand that the responsibility for saving enough for retirement falls mostly upon them. Therefore employees must be effectively challenged to save.
For example, according to the Employee Benefit Research Institute (as of August 2009), the median 401(k)-type plan balance for families with a current employer are:
Age Balance
< 35 $6,643
34 - 44 $22,460
45 - 54 $43,985
55 - 64 $69,252
65 - 74 $56,212
Advisors can dramatically increase the contribution rate through compelling education. From my years of consulting, I learned that what we measure we improve. Measuring the contribution rates before and after your education quantifies its effectiveness.
Perform better fund selection. Advisors should move beyond the "Best of the Best" approach to fund selection. This method of selecting funds by looking at the past performance of the fund universe is harmful to participants.
"Only 17.3% of large-cap funds with a top quartile ranking over five years ending 2001 maintained a top quartile ranking over the next five years ending 2006. Only 10.4% of mid-cap funds and 17.7% of small cap funds maintained a top quartile performance over the same period." [S&P Mutual Fund Performance Persistence Scorecard, Year-End 2006]
Each of these falls below the 25% that random expectations would predict repeating a top quartile ranking. This is a sobering reminder about the validity of the disclaimer "Past performance is not indicative of future results."
Unfortunately the "Best of the Best" methodology relies heavily on past performance as an indicator for future performance. And the impact to the participant is characteristically negative.
When the underperforming fund is removed from the line-up and mapped to the new top performing fund, the participant is forced to sell low and buy high. This process is repeated over the life of the plan by well meaning advisors who inadvertently cause the participant to repeatedly sell low and buy high. That is a tragic mistake.