By Robert C. Lawton, AIF, CRPS, President, Lawton Retirement Plan Consultants, LLC
How does your 401k investment menu compare to the marketplace? Do you have too many investment options or too few? Are you taking advantage of all the safe harbor options available to you? In this low return, low-interest rate environment there is a new set of best practices to use for 401k investment menu construction that includes:
1. One fund per asset class
More than one choice per asset class causes participants to wonder how they should invest in the asset class. For example, should they invest 50% in each fund?
2. At least one balanced option
Studies have shown that between 2/3 and 3/4 of plan participants would prefer to have someone else allocate their 401k plan balance between stock and bonds. Make sure your plan offers at least one type of balanced investment option (e.g.; risk based portfolios, model portfolios, balanced funds or target date funds). The most commonly offered balanced option, by far, is target date funds.
Offer a wide variety of fund choices based on investment objective and risk profile so that those participants who wish to invest on their own may achieve an appropriately diversified allocation. Use the “style box” approach and don’t forget about commodities, real estate and international fund options.
4. A stable value or guaranteed fund option
With money market funds paying close to nothing and variable NAVs, redemption fees and gates on the horizon, it is currently not appropriate to offer a money market fund in a 401k plan. Offer either a stable value or guaranteed rate option instead.
5. At least three conservative choices
Post-crash most participants have become more conservative. Many say they will never again have equity allocations as high as they once did. Offer at least three conservative fund choices. Typically these would include a stable value or guaranteed fund option, intermediate-term bond fund (actively managed or index), high-yield bond fund and/or international bond fund.
6. Index options
A number of your participants believe that index investing is the only way to invest. Offer a sufficient number of index fund options to allow participants to index invest in U.S. bonds, U.S. stocks and international equities.
7. Keep your 401k investment menu simple
Participants are easily confused and discouraged by too many choices. Target 12 to 15 core fund options plus a set of target date funds for a total of around 25 funds in your 401k investment menu. Keep in mind that, according to Vanguard, the average number of investment funds used by participants has remained consistent over time at three.
8. A QDIA
Designate a Qualified Default Investment Alternative (QDIA). For most 401k plans, this will turn out to be a set of target date funds. Those participants who are unsure where to invest, or for whom investment elections aren’t immediately available, will end up investing in this option.
9. Use the cheapest share class
Many mutual funds offer a number of different share classes which have different costs. Make sure that you select the share class for each fund offered that is the lowest cost.
10. Elect to comply with section 404(c)
By complying with ERISA section 404(c), plan sponsors can shield themselves from lawsuits originating from plan participants with regard to the fund line-up.
And you should also consider…
- CITs. If you are a plan sponsor with a larger plan (with at least $50 million invested in target date funds), consider offering Collective Investment Trust (CIT) target date funds. Using CITs can reduce participant costs by as much as 50 basis points in comparison to the lowest cost target date options.
- Passively managed TDFs. There are a number of target date fund series that use index funds as their underlying investments. If your 401k plan is smaller and you can’t use CITs as your target date option, consider using one of these target date series.
- Cultural factors. Some plan sponsors prefer to see at least one ESG (i.e.; Environmental, Social and Governance) investment option, others believe in offering less volatile fund choices. Knowing what your employees will appreciate is important in creating a menu they value.
How does your 401k investment menu compare?
Robert C. Lawton, AIF, CRPS is the founder and President of Lawton Retirement Plan Consultants, LLC. Mr. Lawton has over 30 years of retirement plan consulting and administration experience and has provided consulting services to many Fortune 500 companies including: Aon Hewitt, Apple, AT&T, First Interstate Bank, Florida Power & Light, General Dynamics, Houghton Mifflin Harcourt, IBM, John Deere, Mazda Motor Corporation Company, Northwestern Mutual, Northern Trust Company, Trek Bikes, Tribune Company, Underwriters Labs and many others. Mr. Lawton may be contacted at (414) 828-4015 or email@example.com.
Lawton Retirement Plan Consultants, LLC is a Milwaukee, Wisconsin-based independent, objective Registered Investment Advisory (RIA) firm providing investment advisory, fiduciary compliance, employee education, vendor management and plan design services to 401(k) plan sponsors. The firm currently has contracts in place to provide consulting services on more than $400 million in plan assets. For more information, please contact Robert C. Lawton at (414) 828-4015 or firstname.lastname@example.org or visit the firm’s website at: http://www.lawtonrpc.com. Lawton Retirement Plan Consultants, LLC is a Wisconsin Registered Investment Adviser.
This information was developed as a general guide to educate plan sponsors and is not intended as authoritative guidance, tax, legal or investment advice. Each plan has unique requirements and you should consult your attorney or tax adviser for guidance on your specific situation. In no way does Lawton Retirement Plan Consultants, LLC assure that, by using the information provided, plan sponsor will be in compliance with ERISA regulations. Investors should carefully consider investment objectives, risks, charges and expenses. The statements in this publication are the opinions and beliefs of the commentator expressed when the commentary was made and are not intended to represent that person’s opinions and beliefs at any other time. The commentary does not necessarily reflect the opinion of Lawton Retirement Plan Consultants, LLC and should not be construed as recommendations or investment advice. Lawton Retirement Plan Consultants, LLC offers no tax, legal or accounting advice and any advice contained herein is not specific to any individual, entity or retirement plan, but rather general in nature and, therefore, should not be relied upon for specific investment situations. Lawton Retirement Plan Consultants, LLC is a Wisconsin Registered Investment Adviser and accepts clients outside of Wisconsin based upon applicable state registration regulations and the “de minimus” exception.