Auto-pilot is for airplanes, not 401(k) plans
Businesses that offer their workers a 401(k) plan for their retirement deserve a pat on the back for being responsible, corporate citizens and for helping their employees who seek to build up a good nest egg for their golden years.
But they’re doing their workers no favors by leaving most of the decisions about how those 401(k) funds are managed with the employees themselves, who may know a lot about their particular line of work but very little about the S&P 500 or the pros and cons of investing in stocks vs. bonds.
You know what happens. At the start of his or her job, the employee picks out a few investment products from a catalogue offered by his employer, and there the money sits, year after year, regardless of how it performs (even while other options may be performing better). The retirement plan is basically on auto-pilot, sailing through the storm clouds and clear skies of the stock market with no one at the wheel. From time to time the employee might make a few panicked decisions and move money around based on the ups and downs of the market or a hot, trendy idea, and end up achieving little in the way of returns. As a result, some employees stop contributing to their plans altogether.
Nevertheless, these participant or “self-directed” plans are typically the norm in the 401(k) world. The vast majority of company 401(k) plans are set up this way, where the participant – the employee – chooses the investments for his or her own retirement account based on a menu of choices provided by the employer. Available options tend to be the typical industry products of today; overly broad investments that are built for the masses – not the individual – and certainly not for transparency. And many of these plans, large and small, may be under-serviced and overpriced.
Employees are not investment professionals, and there’s no reason they should be. So why delegate the sole responsibility to them to make the most important financial decisions about their future? Many employers will say they offer their workers educational resources and advice about how to make sound investments. But a three-page brochure doesn’t really cut it.
There is a better way, for both the employee and employer.
Trustee-directed plans can be a MUCH better option for your company and your employees. These 401k plans remove the investment responsibility from the employee and places it in the hands of a qualified investment advisor or firm that manages the investments on behalf of the participant. The plan is managed pursuant to an Investment Policy Statement that clearly outlines all the important facets of how the plan will be managed, what your process is for selecting the advisor, etc.
Investments in a trustee-directed plan can be built with individual securities, where a qualified advisor can most properly manage the investments within the plan. And I don’t think it is a secret that properly diversified and consistently managed accounts have the potential to provide better long-term returns which can lead to much better retirements for employees.
So why don’t more businesses offer trustee-directed plans?
Because they’re afraid of getting their butts hauled into court by disgruntled employees who complain that the company mismanaged their retirement accounts. But this is a misnomer bordering on myth.
In reality, by utilizing a trustee-directed plan and implementing a clear and effective process for selection and monitoring of a qualified investment advisor, a company can help manage their potential liability. Your lawyer should know this.
As a financial advisor who specializes in portfolio management, I’m obviously biased toward the trustee-directed plans. But I’m also a student of facts. Researchers at the Center for Retirement Research at Boston College studied investment data from 1988-2004—an era where stocks produced an average annualized total return of 11.5 percent. They found that employer pension funds – the pooled, trustee-directed plans – outperformed the self-directed 401k plans by an average of about one percentage point per year. Pretty remarkable considering that the trustee-directed plans held a lower portion of stocks during that bull market, yet still outperformed the participant-directed plans.
Just in case you were interested in doing the math on that scenario: the difference an extra 1% annual return would have made over the 17-year period from 1988 to 2004, on a $1 million dollar initial investment, could have been as much as $781,000. Wow.
So, business owner, ask yourself these questions, and be honest:
1. When was the last time you provided education and resources for your employees to make sound investment decisions with their 401(k) plan?
2. When was the last time you reviewed the investments in the plan to determine their appropriateness?
3. How expensive to the participant is the plan you provide?
4. Is the advisor to your plan REALLY a qualified investment professional? What process did you go through to determine that?
5. Can you clearly articulate their investment process?
6) Can THEY clearly articulate their investment process? (I’m not kidding)
Do your employees a solid favor and get your retirement plans off auto-pilot. Give them an opportunity to have a qualified investment advisor make the investment decisions and consider moving to a trustee-directed plan. It might take a little time and effort, but you and your employees should benefit.
There is no guarantee or that a diversified or professionally managed portfolio will enhance overall returns. Investing involves risks that cannot be eliminated.
The opinions voiced in this article are solely those of the author.