With the new fee disclosure rules requiring notifying employees of all fees in their plan by the end of August, 2012 plan sponsors need to take a proactive role. Remember 401(k) plan has become the sole source of retirement for most Americans. It requires and deserves your full due diligence. Plan sponsors must be certain that their plan is for the sole benefit of the plan participants and their beneficiaries.
In addition to exposing the new fee data, the new 401(k) disclosures present an equally important opportunity for CEOs to understand if their plan truly makes sense–for their company and their people. Here’s what to look for:1. Determine your “all-in” cost.
There are two broad sets of ongoing fees that come with your 401(k). The biggest chunk is a fee that goes to the investment company managing the underlying portfolios–which is bundled up into what’s known as an expense ratio. The sneaky thing about annual expense ratios is that they never show up in a statement; they’re deducted from a fund’s gross assets. Investors see only their performance net of fees. Good news, though: Expense ratios are included in the new data disclosures, expressed as a percentage of assets. If your plan uses retail mutual funds, you can also find this data online for free at sites like Morningstar.
The second set of fees covers recordkeeping and other administrative costs. Combine the two, and you have what is known as the all-in cost.
How does your “all in” stack up? A study last year conducted by Deloitte Consulting for the Investment Company Institute broke down median all-in fees by plan size. Though the overall median was 0.78%, the typical charge for plans with less than $1 million in assets was 1.41%. For plans that size, the lowest fees (at the 10th percentile) were 0.99%, and the higher end (90th percentile) was 1.83%. For plans with $1 million to $10 million, the median all in was 1.14%. At the 10th and 90th percentile, the medians were 0.80% and 1.60%, respectively. If your plan’s all in is at the higher end, time to start asking some questions.
2. Confirm you have low-cost index fund options.
There are two broad approaches to investing: Park your money in a mutual fund that’s built to track an established benchmark, such as the S&P 500 index for U.S. stocks or the Barclays Aggregate for U.S. bonds. The other approach is active investing, where there’s a manager or an investment team in charge of making all investing decisions–what to own, when to buy, sell, etc.
I realize active sure sounds more compelling; hire some smart guy, and you will whip the index. If only. I’ll spare you the deep data dive and cut to the chase: The vast majority of actively managed funds underperforms index funds. Pick any time frame and any type of fund (stock or bond, domestic or foreign, etc.), and index funds do better.
My definition of a good 401(k) is one that includes index fund options. Moreover, they should be cheap index funds, ideally with an expense ratio of no more than 0.50%, and preferably lower. If you have index funds that charge 1% or more, that’s just too expensive for a passive investment strategy. I’d be asking some seriously sharp questions at that point.
3. Take inventory of your fund options.
More is not necessarily better in terms of the number of investment options your plan offers. Studies have shown that when there are too many choices, participants get confused or frustrated or just decide not to participate. If you really want to keep it simple–and simple, here, is incredibly smart and effective–I would make sure you have one broad U.S. stock index fund, one broad U.S. index fund, and a diversified international stock fund, preferably an index fund. That’s going to give your plan plenty of bang for the buck. If you also want to offer more specific funds, such as portfolios of small-cap stocks, emerging market portfolios, perhaps a TIPs fund, etc., that’s your call. But don’t go overboard with the number of options.
Plan sponsors should take a more proactive role in the management of the company sponsored retirement plan or seek professional fiduciary help. Many of the fiduciary functions can be outsourced, freeing up staff time and reducing liability.
Please comment or call to discuss how this would affect you and your company.