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Inappropriate use of target-date funds.
Instead of helping workers construct portfolios appropriate for their situations, plans often offer workers target-date funds. Such funds are so riddled with problems that they’ve been the subject of hearings by the Securities and Exchange Commission, the Department of Labor and Congress. Research has found that many target-date funds have incorrect equity weightings relative to their objectives, have inconsistent glide paths1 and, despite identical “target-dates” in their names, lack management and consistency from sponsor to sponsor. Although target date funds are designed to be the sole investment used by a worker, a 2009 white paper by Janus Capital Group found that most of the people who own these investments in their 401(k) plans own six funds (typically a blend of several target-date funds and other mutual funds), which destroys the integrity of the target-date fund’s asset allocation model.
Indeed, nearly two-thirds of those surveyed incorrectly believed that target-date funds are supposed to be combined with other funds. Another common misperception is that target-date funds offer an income guarantee similar to a pension: Nearly 20% of respondents believe target-date funds
offer a guaranteed income stream.
Choosing actively managed funds instead of passively managed funds.
Modern Portfolio Theory shows that choosing — and paying — a fund manager to select securities is more expensive and riskier than building a diversified portfolio composed of a wide variety of asset classes. Since Morningstar notes that, as of December 31, 2009, the average retail fund manager has been managing his fund for less than three and a half years, it is reasonable to question the ability of any manager to produce above-average returns on a long term basis. Fund managers hold securities for six months or less on average, according to Morningstar, creating higher trading costs than passively managed funds.
The Problem of Fees — High Costs for the Worker and Massive Liability for the Employer
Even those workers who are managing to avoid the pitfalls described in the prior section are being thwarted in their efforts to achieve retirement security. The reason: fees. Whereas employers pay all the expenses associated with operating pension plans, the costs of 401(k) plans (including
investment management, record-keeping,custody, advisory, transaction fees and more) are typically paid by the workers — yet they have limited or no knowledge of this, according to the 2007 AARP 401(k) Participants’ Awareness and Understanding of Fees Survey. That study found that:
83% don’t know how much they pay in fees and expenses. The typical 401(k) statement
issued to workers contains information about share balances and share prices, but makes no mention of fees. Instead, fee information is buried in the prospectus and other legal documents, which few workers read and even fewer understand.
Of the 17% who claim to know how much they pay in fees, one-third believe they pay no fees at all. Such misinformation is a result of industry advertising, which often uses jargon such as “no-load” to mislead workers into thinking they incur no fees of any kind.
54% don’t know the impact that fees can have on their retirement savings. A joint study by the Government Accountability Office and the Department of Labor in 2007 shows that a 401(k) account that is charged 2% per year will become worthless 15 years after a 65-year old worker retires, while a plan that charges only 1% will last 20 years, or 33% longer.
Some employers have ignored this concern, believing that fees are not their problem, since they are paid by workers and not the company. This is not only an immoral position, it’s legally faulty — as many companies have discovered to their chagrin. Workers are increasingly objecting to high fees in 401(k) plans, in some instances by suing their employers under the Employee Retirement Income Security Act.
ERISA is the federal law that regulates 401(k) plans and assigns a fiduciary responsibility to employers — meaning employers must create and administer their plans in the best interests of the workers. Those who fail to uphold this duty have been held accountable.
In reaction, Congress has introduced the 401(k) Fair Disclosure and Pension Security Act (H.R.2989) and The Defined Contribution Fee Disclosure Act of 2009 (S.401).
The proposed legislation would require that:
Total fees be disclosed on each employee’s quarterly statement;
Fees be broken down by administrative fees, investment management fees, transaction fees and other fees;
Workers be provided with basic investment information on risk, return and investment objectives;
At least one low-cost balanced fund be offered to protect against liability for participants’ investment losses;
Financial relationships are disclosed to avoid conflicts of interest;
Investment advice be based on the worker’s needs — not the financial interest of those providing the advice; and Plans are structured to weather an economic crisis without firms being forced to choose between cutting jobs or freezing plans.
Fees are not the only weakness of many 401(k) plans — bad investments are as well. An employee lawsuit claims that Merck breached its fiduciary duty by offering its stock as an option in the 401(k) even though the pharmaceutical giant knew it was a bad investment.
Similar lawsuits against other companies are expected — bad news for employers who don’t understand or fulfill the fiduciary obligation their plans impose on them.
While Congress works to address problems with 401(k) plans, possible solutions are already available, for the benefit of employer and worker alike.
How Employers Can Get the Most From Their 401(k) Plans
More than 50% of workers work for companies that sponsor a retirement plan as of 2007, according to the Employee Benefit Research Institute, but many have forgotten why they offer the plan in the first place. Small wonder so many plans today fail to serve the needs of employers and their workers.
When created and administered correctly, a company’s 401(k) plan should help it attract and retain workers. And solely in the and for the benefit of the Plan Sponsor, it’s participants and beneficiaries. Period.
If workers are not overtly enthusiastic about the plan, if new hires do not cite the plan as a significant reason for accepting the job offer and if employee participation rates are not near 100%, then the plan is failing to do its job.
This is why the ideal 401(k) plan will have the following attributes:
For the employer:
Attraction in recruiting and maintaining high-quality workers
Low cost to create, administer and maintain the plan
Ease of plan administration and management
Compliance with all applicable laws and regulations
Low fiduciary risk For the worker:
Low cost to contribute, invest and manage money in the plan
Wide variety of investment choices
Low risk, with returns reflecting the market’s return as a whole
Emphasis on diversification, asset allocation and portfolio construction, not investment selection or market timing
◗ Professionally managed portfolios available for every risk tolerance, time horizon and need
◗ Enables strategic rebalancing as needed
◗ Reduces inclination to engage in market timing and helps workers avoid overreacting to current events Clear and complete periodic statements disclosing all important information about the plan.
Suitable and appropriate investments
Complete guidance and advice to help each employee make the investment decisions that are right for them, including:
◗ Individual counseling by experienced financial advisors
◗ On-site investment seminars
◗ Ongoing communication, such as a monthly newsletter
◗ Informative website
A Better 401(k) Solution
Now that we have identified the problems facing traditional 401(k) plans — and the solution to the problems — why continue with a plan that eats up valuable company resources and does the minimum to help employees plan for their financial futures? By implementing a plan that makes the most of Modern Portfolio Theory and other innovations in the investing marketplace, not only can employers better attract and retain top-notch employees, they can also reduce manhours dedicated to plan administration. Consider the benefits:
Reduced plan administration. Administering a retirement plans costs firms time and money that could be better spent on business development. A better 401(k) solution handles paperwork and other administrative tasks and reduces the burden on human resources staff. It should also closely track regulations and lawsuits regarding employer-sponsored plans, to help ensure that plans remain in compliance.
Higher participation and satisfaction rates. An effective 401(k) plan should be simple enough that every employee should feel comfortable using the plan, while providing the sophistication necessary to offer competitive returns
.
Sophisticated investment solution for all participants. From frontline employees to the executive officers, the ideal solution will offer a wide range of well-constructed portfolios and investment options to satisfy the investment needs of employees — whether their accounts hold hundreds of thousands of dollars or just a few thousand.
Competitive and transparent fees. Avoid the potential hazard of a lawsuit by stating all fees clearly and up front. With a few changes, 401(k) plans can help provide the retirement income and financial security that pensions once offered. Improvements to can be quick, easy and inexpensive to implement.
If you sponsor a 401(k) plan for your employees — small or medium-sized company — the new DOL rule increases your burden and how the TGA 401(k) Plan can help simplify things for you:
1. Should you discover that a service provider (such as a broker or advisor) has failed to disclose any required information, it’s your responsibility to request it from them in writing — giving them 90 days to comply. “If the information relates to future services and is not disclosed promptly after 90 days, [you] must terminate the service arrangement,” the rule states. In other words, you must fire the advisor and find yourself a new one.
Imagine the paperwork, stress and potential disruption to your 401(k) plan that this could cause.
2. The new rule requires that service providers disclose to you by July 1 whether they serve as a fiduciary. If they are not a fiduciary — and you might already know that they are not — do you want to continue such a relationship? You already have a fiduciary responsibility toward your employees, so you may want the service provider who’s working for you to have that same standard and obligation. (The DOL has been considering another rule that would require all advisors serving retirement plans to be fiduciaries, but it has been postponed several times because of industry objections.), but this is coming.
As a Registered Investment Advisor, TGA is a fiduciary, providing advice and service that will be in your and your employees’ best interests. As a fiduciary, we have a legal obligation to do what’s in the best interest of our client.
One of your legal duties as a fiduciary is to understand your plan’s fees and to ensure that they are “reasonable” for the services provided. The new rule should make fees more transparent, but how can you ascertain whether they are “reasonable” — especially if you haven’t been working with a fiduciary?
The best way is to benchmark your plan against its peers.
TGA offers a free benchmarking analysis that shows how your plan measures up to similar plans in terms of cost, return, participation and efficiency.
Benchmarking brings greater understanding of plan fees and services, reveals if you can lower costs and increase
service, and reduces your risk/exposure.
In my advisory practice I strive to help my client partners coordinate their personal and business goals by coordinating their investments, and assuring that their corporate sponsored retirement plans are compliant and cost effective.
By minimizing the exposure of the undue, hidden costs, that should be transparent will help you improve your primary plan intentions to provide; The Benefits to Your Plan Participants..
In the interim, please feel free to call the advisory to arrange a mutual time for our consultation and to discuss your concerns or questions or life-changing events that might require some attention for your plan/participants with the advisory.
It would also be helpful if you would gather any information about your plan; Your Plan Administrator, retirement plan statements, outstanding plan Loans, Venue of Funds or investments provided, your year-end 5500 filing, your current broker, your current investment policy statement, and has there ever been a plan audit requirement
For us to complete this review we will also update the annual plan check list and to assist in a holistic manner with your current plan administration, tax or legal counsel.
TGA can also assure in assisting you in adopting the mandatory, IPS, Investment Policy Statement and we look forward to meeting with you and to provide you with “prudent,” review.
To learn more about us, please take the time and visit; Discover the difference with a Registered Investment Advisor at www.riastandsforyou.com
In the interim, I can be called at; 1-508-224-9646 or contact us at; mgreen@tgacapitalmanagement.com
Best regards,
Michael D. Green, Principal
Fiduciary Management Association
Proud Member-Plymouth Area Chamber of Commerce
Investment products are: Not FDIC Insured, May Lose Value, and are Not Bank Guaranteed. This document is for educational purposes only and is not intended as, and does not constitute an offer to sell or solicit any person to purchase securities. Investment decisions should not be made based on information in this document. Prospective clients should rely exclusively on the offering material when considering whether to invest. Before making an investment decision, prospective investors should carefully consider their investment objectives, risk factors, and expenses before investing. This and other important information is contained in each fund’s prospectus, which can be obtained from your investment advisor and should be read carefully before investing. Material discussed is not to be construed as tax or legal advice. Asset allocation/diversification does not assure or guarantee better performance and cannot eliminate the risk of investment losses. There are no guarantees that a diversified portfolio will outperform a nondiversified portfolio. Diversification does not ensure a profit or protect against a loss in a declining market. Funds and ETFs are subject to risk, including loss of principal. All investments have inherent risks. There can be no assurance that the investment strategy proposed will obtain its goal. Past performance does not guarantee future results. Michael D. Green, Principal of TGA, a Capital Management firm, a Registered Investment Adviser, and provides institutional custodian, Charles Schwab & Company, Inc. member FINRA/SIPC. The opinions expressed herein are those of the writer and may not reflect those of Charles Schwab & Company, Inc or any of its affiliates. 04-24-2013This review is not a solicitation nor recommendation to buy or sell a securities nor to imply any tax or legal advice, always seek a registered investment advisor to attain your risk/averse attitude and investment suitability before investing. All information is considered accurate and reliable, however, due to changing market, economic, taxation, institutional, and other pertinent potential cycles and variations, future results cannot be guaranteed by past performance and should be monitored on a continual periodic systematic basis to provide current advisory recommendations that meets the client short-term potential deviations and management disciplined style, while advisory provides solely long-term recommendations.
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