Challenge of Investing
401K Plan Advisors’ investment philosophy discusses the challenge of investing and its solution.
The basic responsibility given to plan sponsors is included in the Uniform Prudent Investors Act (UPIA). UPIA is a legal document that was published by the American Law Institute in 1992. UPIA states that a fiduciary must follow generally accepted financial theory. A great example of this is called Modern Portfolio Theory. Modern Portfolio Theory actually won a Nobel Prize in 1990 for Harry Markowitz PhD. Modern Portfolio Theory is a scientific way to build a portfolio that can identify and measure the amount of volatility (risk) for any given level of expected return.
Modern Portfolio Theory is the idea that you should diversify, measure risk, and know all costs. Not only are these the plan sponsors primary responsibilities as a fiduciary, but the great news is that there is an academic and scientific method, if applied appropriately, that can give you very good solutions and prudent reasons for making an investment decision.
Ultimately it helps you reduce your liability.
There are some caveats that you need to be aware of in regards to responsibilities that fall on the shoulders of plan sponsors. First, plan sponsors must have a prudent process for selecting funds and investments inside of the portfolios for the participants. It is not enoughto say, “Well, my broker showed me a list of fifteen mutual funds, and we all agreed they had great performance, and so that’s why I picked them.”
That is not a process.
A process must clearly state how these individual funds were chosen, what asset categories were picked, and how they worked together to diversify or reduce risk in a portfolio. This process has to be written down and it has to be monitored to make sure that the underlying investments are actually doing what they’re supposed to do. If they are found not to be fulfilling their roles they must be replaced. This is a very difficult task for anyone who is not an investment expert.
Additional Resources:
- Cost Must Be Carefully Considered
- Hyperactive Management
- Prudent Choices
