Should 401k Plans Offer Only Index Funds?

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By Robert C. Lawton, President, Lawton Retirement Plan Consultants, LLC

A number of retirement plan experts believe that 401k plan participants should only be allowed to invest in index funds. They say the additional cost that participants pay for actively managed mutual funds is not justified by better performance. Some 401k plan sponsors have agreed, offering only index funds in their fund line-ups. Is that a good idea?

Arguments For Using Only Index Funds

Less volatility

There is no question that an index-fund-only line-up will be less volatile than a line-up that includes actively managed funds. Generally, less volatile funds are better for 401k plan participants, who tend to get emotional when markets are volatile, often selling at market bottoms and buying at market tops.

Lower litigation risk

Because index funds are the lowest cost alternative for any asset class, some experts believe that 401k plan sponsors are less likely to get sued by offering them. Given that the majority of lawsuits against plan sponsors have arisen because higher-cost fund options were offered when lower-cost share classes were available, this is probably a valid argument.

In addition, some commentators believe that litigation risk is further reduced when offering an index-fund-only line-up, since this approach eliminates the risk of being sued because a fund is an extremely poor performer relative to its index.

Elimination of advisor conflicts

It would seem that offering an index-fund-only line-up would make it impossible for those advisors working for banks, brokerage firms and insurance companies (who are not fiduciaries) to recommend funds that aren’t in participants’ best interests. Since these advisors work for their employers first, and probably themselves second, client interests generally come in third place. Offering an index-fund-only line-up would make it impossible for these conflicted advisors to recommend funds that pay them high commissions or soft dollar payments.

No more poorly 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 mid-cap index fund mimics a mid-cap index rather than trying to distinguish between mid-cap growth, value and blended funds.

The end of fund changes

If you offer a fund line-up composed 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.

Better performance

We all have seen the data showing that passive management has beaten active for many years. There may be enough data available to conclude that for some asset classes, it is better to choose a passive or indexed approach.

Closet indexers

Unfortunately, there are too many actively managed mutual funds that chart their index way too closely and are in reality index funds charging actively managed fees. These funds (and fund managers) have given active management a bad name and are the primary reason that active management has underperformed passive management so broadly recently. Actively managed fees subtracted from index returns equals an underperforming fund.

Higher level of fiduciary compliance?

Is a plan sponsor better complying with its fiduciary responsibilities by offering an index-fund-only line-up? Because the line-up would be less volatile and lower cost compared with an actively managed fund line-up, some experts think so.

Arguments For Using Actively Managed Funds

Less than 100% of every market downturn

Index funds are guaranteed to capture 100% of every market downturn. An important feature of actively managed funds is that a good active manager can sell out of positions before capturing an entire market crash. Although not every active manager has been able to accomplish this, many have. This is the strongest argument for the use of actively managed funds.

Inefficiencies still exist

Although it will be hard for active managers to beat their index in a number of asset classes that are highly researched and followed, there still are many asset classes where inefficiencies abound (e.g., international equity). Those investment management firms that have research expertise and managerial talent in these areas can significantly outperform their indexes over a full market cycle.

Misperception of active management

I have never understood why there is the widely held belief that all active managers should outperform their fund’s index every year. First, an actively managed fund needs to be evaluated over a full market cycle, not just one or two years. Also, some active managers are very good at defending your investment against loss, but not quite as skilled at outperforming the index during a rising market. And finally, in what industry are 100% of participants top performers? Yes, there are some active managers whose approach is bottom-quartile. Don’t invest with them. Invest with top-quartile managers in every asset class if you choose active management.

Animal spirits

We live in America, where entrepreneurship and innovation are valued and rewarded. Most of our brains are not calibrated to be satisfied with average or index returns. We expect to have above-average children, above-average pay raises and above-average returns in our investment portfolios. Index investing guarantees average returns every single year. I talk with very few investors who are happy with average returns. Many feel that if they experience a year of average returns, that is not a good year.

The Winning Formula

Without question, a winning formula in building a great 401k plan investment fund menu is to combine index offerings with actively managed choices for those asset classes where inefficiencies still exist. But for some plan sponsors, an all-index-fund lineup may be the best approach.

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About the Author

Robert C. Lawton, AIF, CRPS is the founder and President of Lawton Retirement Plan Consultants, LLC. Mr. Lawton is an award-winning 401(k) investment adviser with over 30 years of experience. He has consulted with 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, Northwestern Mutual, Northern Trust Company, Trek Bikes, Tribune Company, Underwriters Labs and many others. Mr. Lawton may be contacted at (414) 828-4015 or bob@lawtonrpc.com.

About Lawton Retirement Plan Consultants, LLC

Lawton Retirement Plan Consultants, LLC is a Milwaukee, Wisconsin-based independent, objective Registered Investment Adviser (RIA) providing investment advisory, fiduciary compliance, employee education, provider 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 bob@lawtonrpc.com or visit the firm’s website at: http://www.lawtonrpc.com. Lawton Retirement Plan Consultants, LLC is a Wisconsin Registered Investment Adviser.

Important Disclosures

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.

Six Keys To Investment Success: T. Rowe’s Brian Rogers Reflects

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I hope you had a wonderful weekend! Remember Valentine’s Day is tomorrow!

LRPC’s Monday Morning Minute for this week, “Six Keys To Investment Success: T. Rowe’s Brian Rogers Reflects” (presented below) comes to you courtesy of ThinkAdvisor. As an independent, objective Registered Investment Advisory firm, Lawton Retirement Plan Consultants, LLC has access to research from many sources. Be assured that I will share enlightening, useful information with you each week. This is a short piece I believe everyone can read in less than 60 seconds.

As his retirement approaches, Brian Rogers, Chairman and CIO at T. Rowe Price, shares his knowledge gained from 35 years working with investments.

Have a wonderful week!

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Six Keys To Investment Success: T. Rowe’s Brian Rogers Reflects

By Emily Zulz, Staff Reporter, ThinkAdvisor

On Brian Rogers’ desk at T. Rowe Price is an engraved cube displaying the reminder, “Doubt everything. Believe nothing.” “And I think those are good things for investors to do,” as well, Rogers said

As the time nears for him to step down from his current roles as chairman and CIO at T. Rowe, Rogers is taking time to reflect on his career. “One thing that really struck me” in 1982 when he joined T. Rowe, he recalled at the event, is how “passive was making increasing inroads into our business.” In addition, he said, “fees were under cyclical pressure in 1982. Fast forward to 2016 and it feels like the same two trends are in place, and will continue.”

Recently, T. Rowe Price announced that Rogers will retire as chairman and CIO on March 31, 2017, after nearly 35 years at the firm. While he will stay on as a non-executive chair, his role as CIO will be taken on by six senior investment executives. Recently, Rogers shared six keys to investment success he’s learned over his career. [Read more…]

Six New Year’s Resolutions 401k Plan Sponsors Should Make

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By Robert C. Lawton, AIF, CRPS, President, Lawton Retirement Plan Consultants, LLC

I hope that 2016 was a great year for you and that 2017 will be even better!

A few changes can make your good 401k plan into a great one. To help your 401k plan achieve greatness, consider making the following 401k plan improvements by year-end: [Read more…]

The Five Deadly Sins Of Investing

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I hope you had a great weekend! Time’s running out for you holiday shoppers!

LRPC’s Monday Morning Minute for this week, “The Five Deadly Sins Of Investing” (presented below) comes to you courtesy of ThinkAdvisor. As an independent, objective Registered Investment Advisory firm, Lawton Retirement Plan Consultants, LLC has access to research from many sources. Be assured that I will share enlightening, useful information with you each week. If you are short on time, make sure you take a look at each of the five headings below.

Sometimes the best way to improve how you invest is to learn what not to do. This week’s article outlines some of the biggest investing mistakes all investors should avoid.

Have a wonderful week!

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The Five Deadly Sins Of Investing

By Daniel S. Kern, appearing in ThinkAdvisor

One of my friends in school was renowned for frequently telling us: “I aced that test!” He was never shy about sharing his answers after a test. His certainty about the answers made me question whether my answers were correct.

I eventually realized that he was wrong more often than right, and he became notorious for misplaced self-confidence. When he joined an investment firm after graduating from school, some of us joked about starting a “contrarian” fund to bet against his stock picks. Overconfidence is one of the “deadly sins” highlighted in studies of behavioral economics.

The investment industry is filled with confident people similar to my friend, who may be well-meaning but who also pass along bad ideas that become accepted as conventional wisdom. Here’s my top five list of investing mistakes that become deadly sins of investing: [Read more…]

Socially Responsible Investing Ratings Can Boost Your 401k’s Value

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PSI Newsletter and Website Header 10.2.15
By Robert C. Lawton, AIF, CRPS, President, Lawton Retirement Plan Consultants, LLC

Recently Morningstar, creator of the Morningstar Star Ratings for mutual funds, introduced Sustainability Ratings to gauge an investment’s adherence to SRI principles. 401k plan participants, millennials especially, have become interested in socially conscious and impact investing. A recent U.S. Trust survey found SRI factors are important to 93% of millennials when making an investment decision. Your 401k plan can have greater value to your employees if you begin sharing Morningstar’s Sustainability Ratings for your 401k investment options. [Read more…]

Did You Hire The Right 401k Investment Adviser?

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PSI Newsletter and Website Header 10.2.15

By Robert C. Lawton, AIF, CRPS, President, Lawton Retirement Plan Consultants, LLC

As a 401k plan sponsor, you are probably aware that there are some new fiduciary regulations going into effect in April of 2017. You probably have spent some time wondering (worrying?) whether these regulations affect your relationship with the investment adviser or investment advisor who works with your 401k plan. They might. Here’s how to tell. [Read more…]

How To Hire A 401k Investment Adviser

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PSI Newsletter and Website Header 10.2.15

By Robert C. Lawton, AIF, CRPS, President, Lawton Retirement Plan Consultants, LLC

Employer plan sponsors often ask me which investment adviser credentials are most important to look for when hiring a 401k investment adviser. As a 401k investment adviser myself, I have observed a number of plan sponsors hiring the wrong advisers because they aren’t looking at the right investment adviser credentials and are using an incorrect set of criteria to judge who is best.

Following are some universal, common sense criteria that plan sponsors can apply when hiring a 401k investment adviser along with important investment adviser credentials to evaluate. The information is divided into what I would consider the three major categories plan sponsors should evaluate: Fiduciary Responsibility, Firm and Background. [Read more…]

What Plan Sponsors Need To Do NOW In Response To 401k Money Market Fund Rules

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PSI Newsletter and Website Header 10.2.15

 By Robert C. Lawton, AIF, CRPS, President, Lawton Retirement Plan Consultants, LLC

The large mutual fund families are doing everything possible to keep you from moving your 401k money market investments away. BlackRock, Federated, Fidelity and Vanguard have all announced changes to their money market fund offerings which they hope will allow them to retain existing 401k money market balances. These changes are in response to the Securities and Exchange Commission (SEC) 401k money market fund reform rules outlined below. [Read more…]

After Reaching New Highs, Can Stock Market Rally Continue?

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MMM Newsletter and Website Header 10.2.15I hope you had a great weekend! Training camps are open and football is back!

LRPC’s Monday Morning Minute for this week, “After Reaching New Highs, Can Stock Market Rally Continue” (presented below) comes to you courtesy of Charles Schwab. As an independent, objective Registered Investment Advisory firm, Lawton Retirement Plan Consultants, LLC has access to research from many sources. Be assured that I will share the most relevant information with you each week. This is a short piece I believe everyone can read in less than 60 seconds.

Where does the U.S. stock market go from here? Are more new highs in the offing, or is a correction just around the corner? See what the experts from Schwab have to say below.

Have a wonderful week!

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After Reaching New Highs, Can Stock Market Rally Continue?

By Schwab Newsroom

It took 14 months and some rather unnerving dips along the way, but U.S. stocks finally climbed to new highs in July. The path ahead could be just as fraught. Stocks could still grind higher in the coming months, but there will likely be more moments that test your resolve.

“Volatility will continue to be elevated, but at this point we believe the U.S. economy should continue to show modest growth, helping to support similarly modest gains for equities,” says Liz Ann Sonders, senior vice president and chief investment strategist at Charles Schwab.

Here’s what you need to know about the market’s ascent and what could lie ahead for investors: [Read more…]

401k RFP Tips For Employers

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By Robert C. Lawton, AIF, CRPS, President, Lawton Retirement Plan Consultants, LLC

Recently my Registered Investment Advisory (RIA) firm has been fortunate to receive a number of Requests For Proposals (RFPs) for investment advisory services. While I am grateful to receive these RFPs, I continue to be puzzled by how some plan sponsors choose to manage their RFP process. So, outlined below, I have provided some tips on how plan sponsors can optimize their 401k RFP process to ensure it produces the best possible result. [Read more…]