By MARK FOLGMANN
We’ve spent the last six articles unpacking the problems and concerns with the small business 401(k). Today we will take a closer look at what an ideal plan would look like so that you may compare your plan with an ideal plan. For my money an ideal plan would revolve around three issues - which would be plan design, cost and overall investment experience. The overall goal should be to create a plan that would allow for the greatest chance of a successful retirement for each and every employee.
We start with plan design because this puts all the triggers and measurements in place to assure success. This starts with a fiduciary process in which an Investment Policy Statement is created with the rules of the plan. This document would specify what our investment strategy is, and why we include certain investments and how and why investments are replaced. It would also point out what we measure success against with regard to indexes such as S/P500 or Russell 2000.
Next we would create an Investment Committee, whom along with a Fiduciary Advisor (RIA) will implement and monitor the process. We would also suggest automatic sign-up and annual increases in salary deferral till an employee reaches a benchmark of 10, 12 or 15 percent. Add in a Roth option because tax-free is the name of the game when possible.
Cost is the next areas of focus within a plan. Start with transparency, if you don’t know who is getting paid and how much – you have a problem.
The only control you have over your plan is the cost and most don’t know what they are paying. I would expect your overall cost within your plan to be south of one percent, and this should include everyone including the advisor. A well-crafted plan should have about .30 percent (or less) for investment cost, .30 percent (or less) for recordkeeping and custodial care and .40 percent (or less) for a fiduciary advisor.
In order to get your investment cost less than .30 percent you will have to utilize low cost institutional class index/passive mutual funds. Since there is no academic proof that high cost actively managed funds outperform the market over long periods of time, we believe the best strategy is to match the market with the lowest cost.
The typical plan I review has all in cost of 2.5 percent or more with many of these fees buried in hidden cost. Once you know who is getting paid and how much, you can monitor and make annual decisions on who needs to stay and who needs to go - this is the plan sponsors fiduciary responsibility. Normally these funds or investments are institutional classes such as Vanguard or Dimensional Funds who do not pay advisors to market them. An annual check-up on all plan cost keeps everyone on their toes.
Lastly we must deal with investment experience of the participants. As stated in an earlier article, the average investor during the boom 1990s only experienced 3.9 percent annual growth from their funds while the market return was over 10 percent a year. Therefore, we should allow professional money managers to create model portfolios and let the employees pick their portfolios based on their individual situations.
The current market has shaken the most sophisticated investors and most are now in agreement that we are not trained to manage our own money.
Last but not least is the use of Institutional Funds vs. retail funds. You want your retirement money commingled with professional money managers, not the typical retail investor who does the wrong thing at the wrong time (all the time). Professional managers are not driven by fear and greed; they are driven by asset allocation and rebalancing. Over time this has a significant impact on the overall investment experience.
A friend of mine Josh Itzoe, author of “Fixing the 401(k)” recently wrote a white paper available on my Web site, which estimates the cost of not having a “Fiduciary Advisor” at $450,000 per participant. You can read the full article at www.arkadvisor.com under the 401(k) section. If you oversee a 401(k) and would like a review of your plan, you can reach me at (231) 668-4118 or mark@arkadvisor.com. Next time we will look at a case study to demonstrate what an inferior plan can cost you over time.
Mark Folgmann is president of Ark Advisors LLC in Traverse City. He has more than 25 years of experience within the financial service industry. This is the seventh in a series of columns discussing topics related to 401(k) planning.
