Investment process matters more than performance

How do 401(k) plan sponsors know if they are receiving good investment advice? That question is more difficult to answer for plan sponsors than it is for individual investors since plan sponsors need to be more concerned about process than performance. It is not necessary for plan sponsors to offer the best performing funds in their 401(k) plans. Rather, they should be more concerned that the process used to select and monitor the investment options offered is compliant and sound. With that in mind, here are some ways plan sponsors can tell whether they are receiving good investment advice.

1. Comprehensive. The advice shared should be comprehensive in terms of ensuring that there are investment tracks available for all types of 401(k) plan investors.

Typically, a 401(k) plan has four types of investors – core funds, do-it-for-me/professionally managed, index and specialty. The adviser should ensure that there are enough investment options available to satisfy all of these investor types. In addition, the advice offered should also be comprehensive in terms of ensuring that there are sufficient investment options offered to allow plan participants to diversify their investment accounts appropriately.

Also see: Why employees need 401(k) investment advice

2. Sound process. The investment adviser should demonstrate a thorough, prudent and understandable process for surfacing investment options for the investment committee to consider. The reports presented should show, at the very least, performance, cost and risk for the recommended options.

Investment committee members should understand the reports and be able to follow the adviser's logic in choosing a recommendation. Keep in mind that every adviser has different criteria for evaluating investment options. For example, I try to surface options that display top quartile measures in the three criteria shared previously. 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 and it is better to offer more defensive investment options in a 401(k) plan than overly aggressive ones.

Also see: Which type of fiduciary should plan sponsors hire?

3. Cultural acceptance. The adviser should understand the client well enough to introduce investment options that are appropriate for their plan participants. For example, I have some clients who refuse to offer real estate or commodities funds to their plan participants because they believe those asset classes to be too volatile and subject to unexplainable price fluctuations.

4. Proper monitoring. The adviser should be presenting monitoring reports that everyone on the investment committee understands. Recommending good investment options is important, but monitoring and ensuring that they remain appropriate is just as important. I would estimate that at least half of all investment committee members do not understand the monitoring reports their investment adviser shares with them during review meetings. The theory that most advisers use is that sharing more information is better since they then can never be accused of not paying attention to a specific measure. However, I would argue that it is the adviser’s job to present those indicators that are most appropriate for determining whether an investment option is doing what it should in the plan.

Also see: 5 low-cost ways to make your 401(k) plan better

The bottom line is that everyone on the investment committee should understand what the investment adviser is saying, doing and presenting all of the time. That is the best way to ensure you are receiving good investment advice.

Robert C. Lawton, AIF, CRPS is president of Lawton Retirement Plan Consultants, LLC (lawtonrpc.com), 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.