Investment offerings have continued to increase, in addition to changing landscapes with environment, social and corporate guidance (ESG) and Department of Labor (DOL) scrutiny. With these changes, there are some key considerations you should take as a business owner building an optimal investment lineup for your employees.
1. Offerings by Style
Research shows that offering too many choices paralyzes consumers. When it comes to investments and retirement plan participants, this means potentially delaying the important decision to contribute to the plan altogether. On the other hand, a diverse lineup can give plan participants with a different investment mindset options to keep them happy with the company’s investment choices.
Only offering an S&P 500, a bond index and a money market might turn off investors who want growth investments or who might want to target an additional 1–2% yield in this low-yield environment. A healthy balance will keep the do-it-yourselfers happy while not overwhelming the set-it-and-forget-it types. While some plan sponsors might feel the pressure to heavily consolidate, you should work to find a healthy balance suited for your unique population of plan participants.
2. Active vs. Passive Investments
It makes sense to have some passive offerings in your plan. This will help lower your fiduciary liability against excess investment fees. Offering an S&P 500 index is a logical choice, and it could be taken further by adding mid- and small-cap index funds for those who favor low-cost investments. Although, there are big differences between, say, the Russell and Vanguard small-cap offerings, knowing the differences might result in more favorable outcomes for your participants.
But this doesn’t mean there isn’t room for both active and passive options for your participants. Great plan sponsors will dig into the philosophy of the investment manager to see if it matches what their participants are looking for. For instance, low bond rates are prompting some investors to increase allocations to equities, which could lead to increased portfolio risk.
A great plan sponsor might offer those participants a value fund that chooses stocks with clean balance sheets, low payout ratios and a history of rising dividends, which have held up well in downturns. Flexible bond funds targeting 2–3% over the bond index or higher-quality high-yield funds might compliment a core bond fund well. In any active investment, the fund manager will hopefully beat their benchmark by an amount greater than their fees.
3. Investment Expenses
One unique characteristic of retirement plan investments is the expense ratio. Because of recordkeeping efficiencies and DOL scrutiny, many asset managers now offer “clean” share classes where participants pay exclusively for investment management expenses. These are typically 0.1% to 0.15% cheaper than share class offerings on brokerage and RIA platforms available to wealth managers for retail assets. Collective investment trusts (CITs) have also now come down market, meaning small plans now have even more access to even lower cost active management than clean shares.
As a plan sponsor, knowing the differences between retail share classes, clean shares and CIT offerings may not only result in better outcomes, but it can also help keep you out of hot water with the Department of Labor.
4. Target Date and Target Risk Funds
A QDIA (Qualified Default Investment Alternative) is a default investment used when money is contributed to an employee's retirement account, but the employee has not made their investment election. That money is automatically invested into the QDIA. This can be further broken down into target date and target risk funds.
Target date funds offer a seemingly straightforward way to diversify investments. Your employees simply select a mutual fund based on the year they plan to retire, and the fund automatically adjusts over time to maintain alignment with investment goals. There’s no need to rebalance or select any underlying funds—the single target date fund provides that service. A dynamically changing mix of assets gradually shifts the risk profile from aggressive to conservative as the target date approaches. While a single investment approach is certainly appealing, a look under the hood reveals some additional complexity that you need to consider when saving for retirement.
Not all target date funds are created equal, even if they share the same target date. One mutual fund may have a larger concentration in stocks, positioning it more aggressively than another mutual fund—meaning many of these funds have an additional risk factor to consider. Each fund has a unique formula to determine the right mix of stocks and bonds for each target date, the number of years until the target date, and the relative level of risk being assumed.
Target risk funds, on the other hand, build a mix of stocks and bonds that align to a targeted risk level. An aggressive target risk fund may put 75% or more of its assets into stocks (with the remaining assets in bonds), while a conservative target risk fund might have the opposite asset mix. If your employees invest in a target risk fund, they just have to select the right risk level for them, no matter their planned retirement age. Keep in mind, your employees will be responsible for adjusting their investments as their risk tolerance changes.
5. Stable Values
You may want to consider utilizing a stable value fund over a money market, as they historically outperform money markets by a healthy spread over various rolling time periods. Analyze the underlying portfolio and the insurance contract(s) to test the stability of the conservative investment in your retirement plan. General accounts deserve increased scrutiny as they typically aren’t invested in just high-quality bonds.
You Don’t Have to Decide on Your Own
With so many things to consider, designing your company’s retirement plan can be overwhelming. How do you know you’re making the right choice for your employees? What else is there to consider that you might be overlooking? You don’t have to answer these questions on your own. Our team of advisors and retirement plan consultants are here to help you navigate the complexities of investment design for your company’s retirement plan.
This information was developed as a general guide to educate plan sponsors but is not intended as authoritative guidance or tax or legal advice. Each plan has unique requirements, and you should consult your attorney or tax advisor for guidance on your specific situation. In no way does advisor assure that, by using the information provided, plan sponsor will be in compliance with ERISA regulations.
The Standard & Poor’s 500 Index is a capitalization weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.
All indices are unmanaged and may not be invested into directly.
The prices of small and mid-cap stocks are generally more volatile than large cap stocks.
Stock investing includes risks, including fluctuating prices and loss of principal.
Investing in mutual funds involves risk, including possible loss of principal. Fund value will fluctuate with market conditions and it may not achieve its investment objective.
No strategy assures success or protects against loss.
There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.
Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise and bonds are subject to availability and change in price.
High yield/junk bonds (grade BB or below) are not investment grade securities and are subject to higher interest rate, credit, and liquidity risks than those graded BBB and above. They generally should be part of a diversified portfolio for sophisticated investors.
The target date is the approximate date when investors plan to start withdrawing their money. The principal value of a target fund is not guaranteed at any time, including at the target date.
CFA®, AIF®, AWMA® Chris oversees the investment management, research and reviews of retirement plans. He focuses on cutting-edge institutional investment research and due diligence on best practices, looking to stay on the forefront of qualified plan optimization, investment selection, participant behavior and fiduciary protection. Chris has an enthusiastic interest in research and the advantages that it can uncover. For fun, Chris enjoys sports like swimming and...Read More