Should 401(k) plans include index funds only?

Commentary: Is it a good idea to remove all of the actively managed funds from your 401(k) plan? Why would a plan sponsor do that? A number of large plan sponsors have dumped all of their actively managed funds, for the following reasons:

• Better fiduciary compliance. Many fiduciary experts believe that greater fiduciary compliance is achieved by offering an investment fund line-up that is as low as possible in cost. Since passively managed or index funds provide the lowest cost, these experts believe that plan sponsors who offer only index funds are in better fiduciary shape.

• Less litigation risk. If you are offering the lowest cost fund line-up possible, it would seem that you are minimizing the risk of getting sued based upon an investment fund cost that is too high.

Also see: SCOTUS questions fiduciary duty to monitor retirement plan investments

• No more bad performing funds. Index funds will always deliver average market performance. An index-only menu would appear to forever eliminate the risk of offering a bad performing, or below average, investment fund.

• Simplicity. Many participants have a hard time understanding the goals and objectives of some of the investment funds in their plans. They may have an easier time understanding that a midcap index fund mimics a midcap index rather than trying to distinguish between midcap growth, value and blended funds.

• The end of fund changes. If you offer a fund line-up comprised of index funds only, will you ever have to make a change to your fund line-up? Maybe not. Many plan sponsors view this as simplification of their plan administration process.

Plan sponsors who have eliminated actively managed funds from their 401(k) plans believe that they have forever addressed the problems of investment fund cost, performance and fiduciary liability. What do you think? Is this a smart way to manage investment options in a 401(k) plan? Share your thoughts in the comments.

Robert C. Lawton, AIF, CRPS is President of Lawton Retirement Plan Consultants, LLC, an RIA firm helping retirement plan sponsors with their investment, fiduciary, employee education and compliance responsibilities. He may be contacted at bob@lawtonrpc.com or 414.828.4015.