How employers know if they’re getting good investment advice

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How do you, as a 401(k) plan sponsor, know if you are receiving good investment advice from your 401(k) plan investment adviser? That question is more difficult to answer for plan sponsors than it is for individual investors. Plan sponsors need to be more concerned about process than performance in order to fulfill their fiduciary responsibilities.

It is not necessary for plan sponsors to offer the best performing funds in their 401(k) plans. Rather, you should be more concerned that the process used to select and monitor the investment options offered is compliant and sound. With that in mind, outlined below are ways you can tell if you are receiving good investment advice.

It is coming from a fiduciary

Your investment adviser is signed on to your 401(k) plan as a fiduciary, right? You should make sure. You also should determine whether your adviser is acting as a fiduciary without exception under the new fiduciary regulations. Many brokers, bankers and insurance advisers are able to act as fiduciaries with certain exceptions (that are not in your best interest). Advisers who work for Registered Investment Advisory (RIA) firms have always been required to act as fiduciaries without exceptions. In other words, these advisers are required by law to provide investment advice that is in your best interest.

It includes discussion of 404(c) compliance and QDIAs

You want your 401(k) plan to comply with ERISA section 404(c) and also offer a QDIA investment option. Holding yourself out as sponsoring a 404(c) compliant plan allows a plan sponsor to be protected from lawsuits related to poor participant investment decisions.

Every 401(k) plan should offer qualified default investment alternative. This investment option is where participant contributions will be deposited if you do not receive investment elections. Plan sponsors enjoy safe harbor protection from participant lawsuits when they invest contributions without investment elections in a QDIA.

Your investment adviser needs to talk with your committee at least annually about whether your 401(k) plan complies with these regulations. Your plan should take advantage of these important legal protections.

It is comprehensive

The advice shared by your investment adviser should be comprehensive in terms of ensuring that investment tracks are available for all types of your 401(k) plan investors. Typically, a plan has four types of investors: 1. Core funds, 2. Do-it-for-me, 3. Index, and 4. Specialty. Your adviser should ensure that the right investment options are available to satisfy all of these investor types.

In addition, the advice you receive should be comprehensive in terms of ensuring that sufficient investment options are available to allow plan participants to diversify their accounts appropriately.

It demonstrates a sound process

Your investment adviser should demonstrate a thorough, prudent and understandable process for surfacing investment options for your investment committee to consider. At the very least, the reports presented should show performance, cost and risk for the recommended options. Investment committee members should understand the reports and be able to follow your adviser’s logic in selecting a recommendation.

Keep in mind that advisers have varying criteria for evaluating investment options. For example, I try to identify options that display top quartile measures in the three criteria shared above. I also place a high value on investment options that have a downside capture ratio of less than 100% since participants worry a lot when markets fall. In 401(k) plans it generally is better to offer more defensive investment options rather than overly aggressive ones.

It fits your culture

Your adviser should understand you, your investment committee and your corporate culture well enough to introduce investment options that are appropriate for your plan participants. For example, I have some clients who refuse to offer real estate or commodities funds because they believe those asset classes are too volatile and subject to price fluctuations that are difficult to explain.

It includes proper monitoring

Your adviser should be presenting monitoring reports that everyone on the investment committee understands. Recommending sound investment options is important, and monitoring and ensuring that they remain appropriate is just as important.

I estimate that at least half of all investment committee members do not understand the monitoring reports their investment adviser shares with them at each review meeting. The theory that most advisers use is that sharing more information is better because they can never be accused of not paying attention to a specific measure. This often leads investment committee members to become confused about what indicators are important and what they are saying.

I believe that the adviser’s job is to present those indicators that are most appropriate for determining whether an investment option is doing what it should. By screening out the indicators that are just producing noise, top advisers make it easy for committee members to determine how a fund is performing.

The bottom line is that your investment committee should understand what your investment adviser is saying, doing and presenting all of the time. If that’s not how everyone on your committee feels, it might be time to look for a new investment adviser.

Robert C. Lawton, AIF, CRPS is the founder and President of Lawton Retirement Plan Consultants, LLC, a RIA firm helping 401(k) plan sponsors with their investment, fiduciary, employee education and compliance responsibilities.

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