What To Do About The 401(k)

Set Your Standard High And You Will Probably Achieve Them; Not Demanding Proof Of Past Success Cost Trillions.Keep It Simple StupidThe screening process for a 401(k) investment should be very simple in today's investment markets>Include a mutual fund or separate account which has achieved reasonable plan members' reasonable investment objectives and include several such investments in every plan. In making your list of eligible investments consider in very basic terms the likely investment trends of the coming decade or so.Screening mutual fund and separate accounts which have achieved investment results worthy of inclusion. Those criteria should be very simple: a ten-year investment track record for the past decade to 3/31/2010 of earning the ratings trifecta Morningstar® 10-Year High-Return, Morningstar® 10-Year Low-Risk and Current Morningstar Five-Star Ratings. To that add a reasonable minimum target return of 7.2% ten-year average annual return (The Rule of 72 would indicate that over ten years that return would double your plan members' money). That screening process applied to Morningstar® Principia® mutual fund and separate account data bases would result in a short-list of 14 traditional mutual funds and 26 separate accounts.Do not assume at this point that allowing Morningstar® Advisory to manage your plan investments is the same thing as subjecting their experience (not back-testing but with live money under management) to similar standards. (You will not find the performance of Morningstar-managed separate accounts for example in their own data bases. You can insist on comparable performance track records and make the comparisons yourself.)The final screening test is to request all of the 40 funds and separate accounts on your list to address in writing three questions about likely future markets:1.How will your investment strategy react to a period of rising bond interest rates? Bond returns are at all-time low levels, the profits to be made may be behind them and the extra appreciation which has buoyed bond fund total returns higher than the bonds in which they invest all three of which can hurt interest rate sensitive buy-and-hold investments. Asking the managers of the fund to address the impact of the funds' average maturity, duration and average credit ratings on fixed-income investments and actions they plan to take over the coming decade and did take over the past decade to protect their shareholders from declining stock markets domestic and foreign will both help you and eliminate funds which have not and will not take any defensive action. Then ask them if they plan to and did "go 100% to cash," sell securities short or hedge against expected risk in an adverse bear market.2.How does your fund take advantage of foreign stock profits when the value of the US Dollar is generally declining? What will your fund managers do if the value of the US Dollar is generally rising? Did you and will you reallocate your portfolio significantly enough to take advantage of rising foreign stock markets and a falling US Dollar?3.Assuming that avoiding expected stock market risk over the coming decade is as important to minimizing market volatility risks and avoiding known risks over the past decade, what actions will you take to protect shareholders' principal?What you will learn by asking these critical questions is 1.that some funds on the your list of 40 candidates for inclusion in your 401(k) plan are buy-and-hold stock and bond funds that are committed more to staying in their style-boxes than to making investors' positive returns.2.Most mutual fund families have no effective plan in place to avoid probable risks of a down market. Their prospectuses forbid such action.3.As ETFs offer over 800 unique investment sectors from which to choose as investments and traditional fund families offer only about about 80 mostly domestic and mostly broad index-based funds, there are many investment opportunities for low-risk high-returns are being missed. For example, during many recent years, a combination of a falling US Dollar and rising stock markets in commodity-driven economies in a seller's market in raw materials (Canada, Russia, Australia and Brazil) have presented low-risk high-return opportunities for US investors. Conversely when a falling Euro started a flight to quality in US Treasury obligations it was wise to reallocate assets to domestic stocks and bonds for a time.Finally, ETFs offer on average about 50 BP lower expense ratios than traditional funds and a potential (due to the broad diversity of foreign stock and domestic sector investment choice) of on average adding 150 BP alphas. That 200 BP potential advantage is more than enough to invest in an experienced independent registered investment advisor to proactively manage a portfolio of ETFs for your 401(k) plan's participants.You will note that at no point does the subject of "target maturity funds" (whose disastrous performance track record and unjustified additional management costs knock them out of the block), annuities (which produce a cash flow that is part return of principal and part distribution of investment returns, the latter of which has not been realized by variable annuity holders of late, beside who wants to lock in today's low yields when tomorrow's potential fixed-income yields are more likely to be higher than lower), Lifecycle funds (so far, of little use to retirement savers close to retirement (and thus no longer having a long-term to enjoy), or similar extra cost for no real extra benefit investment choices.Keep in mind that compounding only works when you earn positive returns.Also keep in mind that the total of America's Retirement Savings (tax-deferred plans like 401(k), 403b, IRA and variable annuities) was $11.1 trillion on 12/31/1999 and it was $14.4 trillion as of 12/31/2010. If investors had simply invested in money funds for the decade and avoided the two bear markets during which few if any buy-and-hold investment choices took any action to protect shareholders' money (even calling the risk and need to reallocate assets to their attention) there would be $28.4 trillion in America's Retirement Savings, not $14.4 trillion.There is a lot of good money being thrown after bad in the retirement savings market due to the promotion of buy-and-hold-only investing. The tax-deferral didn't work over the past decade because negative returns arrived twice and arrived hard. The convenient payroll deduction and tax-deduction of contributions, employer matching contributions and conservative investment choices (such as company stock and tragically-managed target maturity funds) were decidedly bad investment advice which arrived with the approval of Congress and ERISA which is still dragging its feet on what is "appropriate investment education.The above screening on investment choices is a good start toward avoiding employer liability while adding the potential doubling of investors' assets over a ten year period.

Very well said

Stephen raises a number of very important issues, many of which had he expand upon would have lengthened the article quite a bit. That said, I'd like to add clarity to some of those issues due to their importance. 1) A plan sponsor has no obligation to offer a retirement plan let alone ensure it helps participants reach retirement financially independent. A company's only obligation is to administer a plan according to ERISA and ERISA does not guarantee results other than minimum promised benefits in a DB plan under Title IV...the PBGC. It is important to keep this in mind as we focus on plan or participant success in relationship to rating systems that compare plans based upon their participant accumulations and deposits. 2) A plan sponsor is not obligated to provide investment education or advice. Both are optional services that have a cost and this cost is typically borne by all participants but in many cases only benefits some participants. It is not unusual for the cost of computer based investment advice to be shared by all participants but only the highly paid use and benefit from the advice. One on one advice paid by the participant is a targeted delivery system where the person that pays for the advice receives the benefits of that advice. 3) The market melt down of 2008 affected Defined Benefit as well as Defined Contribution plans. As a result many DBs that were over-funded became under unfunded no differently than those participants who were on target to reach retirement financially independent were no longer on target in a 401k. However, in my opinion, if there is a flaw in the 401k plan it is tied to participant behavior that results in a failure to save sufficiently. Many participants will fail to meet their retirement objectives even if 2008 never happened. 4) Participants can't be expected to do something advisors can't do. Navigating market cycles is difficult for professionals let alone participants. The 2008 melt down was more of a reflection on the SEC that failed to enforce ethical behavior than it was a result of poorly informed participants. Few if any advisors or investors escaped 2008. 5) It was professional money managers that caused the 2008 meltdown, not participants. Participants were the victims...consider that Bernie Madoff did business with RIAs, as did Lehman Brothers, Bear Stearns, AIG, GoldmanSachs, Merrill Lynch all of which found their fate tied to 2008. Again, if these firms could not avoid the market melt down how could Registered Reps, RIAs or investors. 6) If the government wished to correct the system they would restrict 401k access to investments that don't pay anyone indirect fees, establish minimum educational and experience standards for advisors who wish to render services to retirement plans or participants, and aggressively enforce ERISA standards. There are far too many ill-equipped advisors serving the plan sponsor market. 7) The debate over fees continues to rage on. Any fee that is tied to a conflict, self-dealing or kickback, no matter how reasonable, is prohibited and must be disgorged. Unfortunately, few plans attempt to document reasonable fees by assessing their fees in light of services rendered and far too many plans either over pay for services promised but never delivered or for no services other than the original placement. Logically, experts should charge more than generalists but there are examples of generalists charging more than experts. However, to my knowledge, there is no empirical evidence to suggest an RIA specialist charges less and a registered rep generalist. What is consistent is the lack of process to evaluate fees to determine if they are reasonable and the lack of advisors defining the services they render for the fees they charge. 8) A plan sponsor and their fiduciaries remain liable no matter who they hirer because hiring an advisor is a fiduciary act. The benefit of hiring an advisor, from a risk mitigation stand point, is too reduce or share the liability. In other words, someone to share the cost of monetary damages if they exist. This, of course, assumes either the advisor has the capital to underwrite any claim or the advisor has the appropriate fiduciary E&O to cover the claim. Unfortunately, there are many advisors providing plan and participant level advice that do not have fiduciary insurance or the capital to back up a claim. 9) An RIA is not the only person that can be hired to provide a "fiduciary wall" of protection assuming the RIA has expertise and is properly vetted. For example, a Trust Department can offer trustee and discretionary money management services. In addition, they are required to meet minimum capital requirements not applicable to an RIA. In fact, even a dually registered IAR rep that is subject to B/D compliance oversight could argue they offer more protection than a pure RIA due to the capital requirements of the B/D assuming the B/D has implemented all appropriate steps to support retirement business including fiduciary E&O. Also, a plan sponsor can outsource "named fiduciary" responsibilities to an individual that is not an RIA...a model that is gaining some momentum. Keep in mind that ERISA only references RIA status under 3(38) and 408(g)(11)(A)(i) it is not mentioned under 3(21). 10) There is nothing finalized that requires the disclosure of fees to participants in 2010. In particular, trading costs and bid-ask spreads are very difficult and expensive to obtain. For mutual funds, trading fees are available in the Statement of Additional Information but must be calculated by hand. Unless the advisor has access to Bloomberg or ITG, which both could add overhead cost to managing a retirement plan, we must wait for formal a mandate that would impose cost disclosure although I think most believe this is coming. 11) New schedule C requirements now require the reporting of direct and indirect compensation. There are disclosure exceptions if the compensation qualifies as "eligible" indirect compensation. Unfortunately, the DOL did not provide us with detailed definitions of the 55 service codes which will make it difficult to rely on the Schedule C data for expense benchmarking. Of course, this only applies to 11% of the plans that are required to file the Schedule C. 12) A higher level of investment management can only be provided by a qualified advisor. Unfortunately, there are many RIA's that are generalists, not ERISA specialists. In fact, regardless of registration or licensing, there remains many individuals collecting compensation on retirement plans that are generalists ill-equipped to do the job. This should change as plan sponsors, attorneys, and CPAs embrace the Center for Due Diligence's ERISA Advisor Evaluator (EAE) RFP system. EAE provides what the industry has been lacking for decades...a documented process to identify, analyze, evaluate, select and monitor qualified advisors. What appears to be a theme we can all agree with is the need for plan sponsors to retain the services of the advisor. Surveys tell us 20% of the retirement plans operate their plan without an advisor. That is over 130,000 plans that believe they know as much or more than an advisor. These plans are operating at great risk if they cannot prove they have the skills of an advisor acting in like capacity and familiar with such matters a person would use in the conduct of an enterprise of like character and with like aims. At the same time, the job they are doing is, in many cases, no worse than the job a generalist does without the cost. Advisors that specialize in retirement plans and understand their ERISA obligations can offer a great deal of value to a plan sponsor if they can be reliably identified. Our industry needs to do more to train and equip advisors to become experts in ERISA. In addition, our industry needs to lead by example and restrict retirement plan engagements to those advisors that are qualified to handle engagement but that is unlikely to happen unless it is legislated into effect. In the meantime, plan sponsors will be informed that they must and can adopt a prudent documented process for selecting and monitoring advisors to manage their 401k plan in compliance with ERISA.

I didn't say fiduciaries are aware of their expenses nor did I say that RIAs are not the best model or that small plans have low expenses.Plan expenses are all over the map, but the industry is riddled with falsehoods about expenses. There are always exceptions, but mid and large plans do NOT have high expenses. Small plan expenses are generally high becasue the plans lack assets and the sponsor charges the recordkeeping/administrative expenses against the plan. The average RIA fees in the small plan market are comparable to the embedded commissions in broker sold products. The RIA MAY be a better bargain, operate at with a higher standard and be better equipped to educate plan participants, but their fees are comparable to the commissions embedded in broker sold proudcts in the "small" plan market. Nobody can market time, no point in wasting time talking about that. Also, no point in talking about generalists. One is a specialist or they aren't. Registration status has nothing to do with specialization. Generalists should not be serving retirement plans.

Dear PhilI appreciate your response and constructive criticism. My statement "provide a Fiduciary wall to mitigate trustee liability" was not meant to suggest plan trustees will have no liability by hiring an RIA. It was an attempt to find a word to suggest a reduction of liability. Thank compliance for that.Again you're correct that when a plan trustee/fiduciary hires an advisor their first duty is to determine the voracity of the advisor. If an advisor with little qualification is hired there would likely be very little protection from fiduciary liability.I'm not a lawyer, I'm an advisor, and I see things through the eye of personal liability. Taking on a role of Fiduciary is serious business. I pulled an article off your very informative website written by [b]David J Witz in June 08 on section 408(b) (2) on the Proposed Regulations and ERISA's General Fiduciary Obligations [/b]which is a very comprehensive treatise on a very complex subject. It re-affirms that the average plan trustee knows little of their liability where DC plans are concerned. However I take issue with the rest of your comments. Perhaps you should re-read the article since it aptly points out that Fiduciaries know little of the expenses they incur. Are we talking about the fortune 500 or Main Street? To suggest that the average 401k has a fee structure like that of multi billion dollar plans with all in at 10 bps is preposterous. What planet are you on? I come across plans consistently with expenses that range from 175-225 bps all in. Most low expense plans (Fidelity, Vanguard or the like) I've seen have no advisor associated and as a result have a poor education component at both the plan and participant level. Recently I encountered a major financial institution with a wire house sponsored plan on an ancient platform with a 175 bps cost and the commissioned broker as advisor.You seem to suggest that the fee-based model is no bargain. Quite the contrary it's the best option. All in fee's range in the 105-125 bps with a qualified advisor providing valuable, relevant advice and access to ETF's and instutional funds.Also your assessment of participant performance befuddles me. Again where have you been? Academic research consistently re-affirms the propensity of the un-sophisticated investor to sell low and buy high. True nobody escaped the downturn, but so many avoided the upturn as well. The real point here is who is in the best position to offer un-biased relevant advice to a plan participant. The DOL doesn't think it's the guy who gets 12b1 fee's as comp.

There are a number of major inaccuracies in the article on "What To Do About the 401k, but I will only address two here. The statement noting that only a contracted RIA can assume fiduciary liability and provide a "fiduciary wall" of protection for trustees is absolutely NOT true. That arrangement does NOT eliminate the plan sponsor's fiduciary responsibility or potential liability. It may, however, provide the basis for argument in defense of fiduciary litigation, but the sponsor's lack of due diligence and/or monitoring of the alleged independent fiduciary could just as easy fuel the litigation . In short, the arrangement does NOT eliminate the sponsor's fiduciary responsibility or liability to hire and monitor that advisor. Furthermore, any plan sponsor who hires an advisor, including an RIA, without performing meaningful due diligence on that advisor has already breached their fiduciary responsibility. Given that most sponsors don't know how to evaluate expert retirement plan advisors, that is a major problem. RIAs, particularly generalists, should not be fed this nonsense. Registration status does not make one an expert. Your comment about the flaws in 401k plans during the 2008 meltdown was also ridiculous. The investment markets were the problem in 2008, not 401k plans. Nobody escaped the sword. Your notations about choosing an appropriate asset allocation and navigating the extreme market cycle without taking a major loss is way off base. The only asset class that escaped the meltdown was cash, stable value or treasuries. That doesn't mean an equally weighted multi-asset portfolio with annual rebalancing isn't good. It just didn't work in 2008.You also need to stop drinking the home brew and acknowledge that mid-sized 401k and large plans do NOT have high expenses. Many large plans are all in at 0.10 bps. Mid and large 401k plan investments have also been subject to rigorous due diligence far beyond the typical small RIA.Small plans that purchase broker/agent sold products may have embedded commissions comparable to the typical 1% charged by RIAs, but that isn't the real problem. Small plan sponsors charging the fixed recordkeeping and administration expenses against the plan are the problem from an expense standpoint. When plan assets are small, those fixed costs drive up total expenses. Ideally, sponsors would pay the qualified expert RIA fees and the plan recordkeeping and administrative fees directly. Small plan sponsors are also serviced by generalists, including RIA generalists, another major problem. RIAs can do much to help the average investor, but registration aside; generalists are not a solution for the retirement plans market. Rather than cheerleading and misinformation, the RIA industry needs an accurate source of information re the retirement plans market. Phillip Chiricotti, President, Center for Due Diligence.