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What Happens to Your 401(k) Investment Menu When the Tide Goes Out?

Thank you Jamie Axford of Putnam Investments for taking the time to join me on the 401(k) Fridays Podcast! If you missed Part 1, check it out here! In Part 2 of 3 in our mini course on "The Fundamentals of 401(k) Investment Menu Construction" we covered some great points for employers on selecting the asset classes and specific investment options you may include in your 401(k) investment menu. If you have not had a chance to listen to this episode please click the player below.

Now for this installment of the 401(k) Fridays Fiduciary Fact and Folly!

On the scale of impactful decisions you make as a plan fiduciary, designing your investment menu is right up there at the top of the list. As a retirement consultant when I help guide employers through this process, the conversations change but the motivations to select quality investments, at a reasonable cost and in a way that will both discharge their fiduciary duties and help participants improve their retirement outcomes are fairly consistent. The good thing is that nearly every plan sponsor is looking to make the best decisions they can, however it is today’s fiduciary fact that many plan sponsors, while having the best of intentions, don’t always arrive at the best outcomes for their plan or participants.

To put things in context, we don’t run into too many people that sit on investment committees that are investment experts. Some obviously have more knowledge than others, but true experts are few and far between. As such, most investment committee members are relying on the tools, resources or guidance from an outside party to help them make decisions about the investments to offer their participants. Whether the investment analytics tool you are using to help you select investments to either offer or remove from your investment line-up, uses stars, scores, a stoplight system, etc. I beg of you to take a few extra minutes either prior to or during your next committee meeting to understand the basics of how that tool works. In this episode we talked a lot about terms like risk, style consistency, risk adjusted returns and several others. While I am not suggesting that I or any of the guests on the podcast have cracked the investing code, or that these are the only concepts you need to be aware of to create the ideal process to select the best funds to include in your 401(k) plan, my hope is that with this mini course on investment menu design you will be better equipped to navigate discussions you will have about selecting investments going forward.

One reason I created this mini course was to make whatever contribution I can to help plan sponsors avoid a cycle I have seen play several times. It goes something like this, as a plan fiduciary you want to make the “best” decisions for your participants when selecting investments for their retirement plan. As such, you logically rely on the scoring results from the investment analytics tool you have aligned with. In reviewing the information, you would generally assume that the highest scoring or best rated investment by the tool is naturally the best choice to include on your investment menu, why wouldn’t you! It is hard to argue with that logic that 5 stars is better than four, a fund scoring a 95 is better than one scoring a 65 and so on. Many times, things turn out well and a year, three years or more down the road all is still well with your plan and the investments you have chosen. However, what I have seen happen in certain market cycles, is tools can either favor or penalize investments with certain styles and risk levels. As such, plan fiduciaries selecting a highly rated investment that earned a strong rating during a long period of largely benign market conditions can quickly fall from grace when the directional tides of the market change. Pretty soon the rating or score starts to fall, the investment goes on your watch list, next thing you know it is time to remove it. Then, the prevailing tides of the market change again and the investment you chose to replace it is now on your watch list! This is a ride you don’t want to be on!

As we sit here in October of 2016, we have had a strong bull market in stocks or equities that started in 2009 during the depths of the financial crisis. Many tools place a lot of emphasis on data gleaned from three and five year look back periods for a particular investment. In a market with a fairly strong upward trend and only minimal downside volatility, many investments that have generated the best performance during those periods have been handsomely rewarded with high ratings by some investment tools plan sponsors rely on. Something to think about, with the bull market now over seven years old, is evaluating an investment relying heavily on what it has done over the last three and five years the best predictor for how they will perform in the coming years? Maybe, maybe not! What gives me pause is that several of the “best” investments today are also the ones that carry a lot of downside risk which has been masked by the strong upward trend in the market.

As a plan fiduciary, there is nothing wrong with selecting a risky investment for your plan and for use by your participants. However, where I do see potential trouble brewing on the horizon is when plan sponsors unknowingly are steered towards or away from investments because there is not an adequate job done to understand or explain their risk profile. You don’t have to become an investment expert to ask questions about the risk profile of your current or potential new investments. The financial professionals you work with should be able to provide answers to you in a way that you can understand. If they can’t, it might be time to find someone who can! For today’s fiduciary folly I leave you with a quote from someone who is regarded as one of the best investors of our time, Warren Buffet, “Only when the tide goes out do you discover who’s been swimming naked.”

If you would like help evaluating the risk levels in your current investment line-up, or with investments you might be considering, send an email to Who knows, we might be able to help!


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