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Monitoring Your Investments - Class 304

Investment selection can be one of the more challenging duties of the 401(k) Investment Committee. Although the world of mutual funds may seem endless, there are ways to narrow your search to eliminate the options that may not be the best fit for your plan. Today, we'll be talking about the policies and procedures you can put in place to help safeguard your investment selection process.

Although there are many different aspects to running a retirement plan, many plan sponsors focus most of their attention on the investments offered within the program. If you are contributing as much as you can as a participant each year, this makes sense as one of the few thing you can do to further influence the growth potential of your account is selecting the most suitable investments for your particular set of circumstances.

As a member of the Investment Committee, your primary obligation is to build and maintain an investment menu on behalf all of the plan’s participants regardless of their age, risk tolerance, or time horizon until retirement. This means that your fund line-up should be designed for all participants regardless of whether they are just beginning their career, are well into retirement, or are anywhere in between. Therefore, we typically suggest building a fund line-up that offers a mix of investment options from different asset categories. Although each advisory firm has a slightly different stance on the asset categories that should be offered within a 401(k) Plan, the basic framework of a fund line-up may look something like this:

  • Target Date Funds (options from 2025 to 2065 as well as a Target Date Income fund)
  • Preservation-of-capital option (Money Market or Stable Value fund)
  • Foreign Equity
  • Fixed Income options
  • Domestic Equity
    • Large Cap options (Growth, Value, and Blend)
    • Mid Cap options (Growth, Value, and Blend)
    • Small Cap options (Growth, Value, and Blend)
Likewise, we suggest offering a variety of passively and actively-managed funds. In general, many plan sponsors use index funds for the Intermediate-Term Bond, Large Cap Blend, Mid Cap Blend, Small Cap Blend, and Foreign Large Blend asset categories. For example, we have found that many investors like to invest in a fund that tracks the S&P 500 index. As a member of your Investment Committee, you could offer an S&P 500 index fund as your Large Cap Blend fund and then offer actively-managed funds for the Large Cap Growth and Value categories. This would offer the plan participants a variety of options whether they are more interested in growth, value, or blend and passively or actively-managed funds.

The big question then becomes "How do we score our investment options for performance and fees?" First, let's tackle the fee question. As a Registered Investment Advisor, we typically recommend our clients access the lowest share class available for each fund you are adding to the investment line-up. If you need a refresher on mutual fund share classes, please revisit Class 106. Since the difference between a fund’s gross returns and its net returns to the investor is the expense ratio, we want to make sure we are reducing the expense ratio as much as possible. From a fee perspective, funds in an institutional share class or an institutional share equivalent might be suitable investment options for your plan.

We then move on to scoring the performance of the investment options within your retirement plan and the fund options you might be considering to add to the lineup. Although I typically recommend engaging a retirement advisor who serves as a fiduciary on your plan, I understand that this is not always feasible so I can give you some high-level education and best practices on this topic. First, it is considered a best practice that the Investment Committee meets to score the plan’s fund options at least once a year. Furthermore, it may benefit your team to run a report each quarter to see how the funds are performing versus their peers. These reports and any Investment Committee meeting minutes can be stored in an ERISA file showing how you have arrived at the fund line-up you currently have in place.

If you engage a fiduciary advisor for the retirement plan, the advisor should help steer you through these processes. If you do not have an advisor assigned to the plan, the onus lies predominantly on the Investment Committee to make sure the investment options are being reviewed regularly and the committee has a reasonable rationale for selecting the investments that make up your fund line-up. For example, the committee would have a difficult time defending the fact that Fund X has been offered within the 401(k) for the last several years and it has performed in the bottom 75th percentile among its peers during this time. If the committee’s primary job is to run the plan in the participants’ best interests, knowing that 75% of Fund X’s peers have stronger performance histories could place the Investment Committee in a position of liability as it could be argued that they are negligent in their duties as fiduciaries.

By following the Investment Policy Statement and regularly scoring the plan’s fund options for performances and fees, the Investment Committee can show that they have a procedure in place for overseeing the investments and they are fulfilling their obligations as fiduciaries on the retirement plan. Join us for next week’s class when we discuss the importance of maintaining meeting minutes in your fiduciary process…

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