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Individual choice in 401(k) funds could yield lower returns than an investment advisor’s selections
Registered investment advisors may do a better job investing for employees than workers would for themselves.
Are your employees not getting the returns they want from their selections of investments in their retirement plans? Consider handing the decision-making responsibilities over to a registered investment advisor (RIA), some experts suggest.
Individual 401(k) participants who select their own investments usually do not get as good returns, in the long run, as plan participants who let RIAs make investment decisions for them.
Some 401(k) participants are too aggressive and spend far too much time managing their retirement accounts, said Jeffrey Chang, an attorney with Chang, Ruthenberg & Long in Folsom and San Jose, Calif. But most are simply too conservative in their investment choices, he added.
Most individuals in mutual funds invest much more poorly than the market performs as a whole, whether from fear, greed or attempts to time the market, he told SHRM Online, citing studies on individual investor behavior conducted by Dalbar Inc., a leading financial services market research firm based in Boston.
Chang noted that one of his clients, a lumberyard in California, had 300 participants who cut or hauled lumber. As investors go, they were relatively unsophisticated and had most of their investments in money markets that did not earn anything. Given the fact that most of these workers were relatively young and had many years to work before they retired, they were wasting a critical opportunity to take advantage of compounded tax-deferred earnings within their accounts.
The single most important determinant of investment success is proper asset allocation—selecting and maintaining the right mix of investment types (e.g., stocks, bonds, cash, real estate, international, etc.), not whether the participant can change one fund for another on a daily basis, Chang said. Chang talked to the employer about the 401(k) plan accounts for its employees, which weren't doing well, and convinced the employer to switch to a nonparticipant-directed 401(k) plan overseen by an RIA.
Following the advice of its advisors, the employer switched the plan's investments to age cohorts with an 80 percent to 20 percent stock to bond ratio for younger participants and a 60 percent to 40 percent stock to bond ratio for older participants. The plan was a huge success with the individuals enjoying higher returns, Chang noted. Many of the participants thanked the employer for taking the "burden of investing their retirement account off their shoulders."
The prototypical 401(k) plan investment structure does not effectively promote proper investment of retirement assets, wrote Erin Turley and Allison Wilkerson, attorneys with McDermott Will & Emery in Dallas, in an e-mail to SHRM Online. "Participants often lack the knowledge or time to properly analyze investment alternatives offered throughout the plan and, therefore, are not the best decision-makers when it comes to generating investment returns."
Participants may invest speculatively, which is unlikely to increase returns. Or they may be plagued by inertia, they wrote. Sometimes the main investment used under the plan is the plan's default fund.
An RIA "simply has more skill and experience in investing assets," they wrote. "An RIA is dedicated to managing the investment of plan assets and can act quickly to do so where it is not uncommon to find participants who do not manage or direct the investment of their retirement benefits more than once a year, if then."
If using an RIA, plan sponsors should make sure he or she accepts full fiduciary responsibility for the investment decisions that are made, they said. Have a written advisory agreement with the RIA in which the RIA accepts full and independent fiduciary responsibility as a "3(38) investment manager" under Section 3(38) of the Employee Retirement Income Security Act (ERISA). Under Section 3(38) the plan sponsor may delegate the selecting, monitoring and replacing of investment managers to an outside investment manager who is an RIA. The plan fiduciary still must properly select the RIA and continue to monitor the RIA to ensure he or she is acting as required, Turley and Wilkerson noted. "This does not require the plan fiduciary to second-guess the RIA's investment decisions but does require regular reports and documentation such that the plan fiduciary can assure itself that the RIA is acting appropriately," they wrote.
Antoinette Pilzner, an attorney with McDonald Hopkins in Detroit, and Chang noted that plan fiduciaries can protect themselves from investment-related liability by:
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