I hate the “F” word.  You know the one I am talking about:  Fiduciary. 

401(k) salespeople love to talk “fiduciary responsibility” – The only problem is that most of them have none.  If you are a business owner with a 401(k) plan, fight back with a few pointed questions.

1.Who is the Named Fiduciary?  For most small 401(k) plans the named fiduciary (sometimes referred to as the “Plan Sponsor” or “Administrator”) is the business owner or CFO whose name is actually listed in the plan documents. You won’t find the names of  that 401(k) salesperson, accountant, or Third Party Administrator in the plan document.  The buck stops with that owner and s/he can never completely delegate away that responsibility.

2. Are you regulated under the Investment Advisers Act of 1940?  401(k) advisers come in two distinct flavors – Registered Investment Advisers (RIA’s) are regulated under the act and are always considered fiduciaries that have to put the clients’ interests first.  Registered Reps, insurance agents, and brokers (which follow the less stringent “suitability standard”) are not.

3. “Do you have complete discretion over plan investments?”  If the business owner/named fiduciary can ultimately take or leave the investment advisers recommendations, then the real liability for those investment choices still rests with that business owner.

Here Are A Few People Most Of Us Would Mistakenly Think Of As Fiduciaries:

The Adviser:  Again, unless they are a Registered Investment Adviser (RIA) they will wash their hands of responsibility when things go wrong.

Third Party Administrator (TPA) or Record-Keeper:  We all depend heavily on these people to handle the red tape, but they are not plan fiduciaries. For  example,  they prepare IRS Form 5500 for you, “signature ready.” But guess whose signature goes on it?  Hint:  It’s not the TPA’s.

The Trustee:  Unless they have complete discretion over the plan, that trustee (usually the insurance or mutual fund company) is a “directed trustee”.  Guess who “directs” them and is still liable?  Yup, you guessed it:  The business owner.

Other Gimmicks:

Fiduciary Warranty:  Read the fine print.  The warranty only says that you will be given a diversified (meaning one stock, bond and cash fund) investment menu.  That is only one narrow slice of the fiduciary pie.  The majority of 401(k) lawsuits involve excessive fund costs and this is not covered in the warranty.

Co-Fiduciary Status:  I like the sound of this but the term does not exist in ERISA law, so everyone seems free to define its meaning differently.  No real protection here.

So what can a plan sponsor do? 

First, keep your risks in perspective.  How many business owners who sponsor a 401(k) plan and oversee it in good faith, have actually been sued and lost?  My guess is that given the number of plans out there it would be statistical noise.  Want proof?  Look at the cost of “fiduciary insurance” – it’s cheap for a reason.

Finally, hire a knowledgeable Registered Investment Adviser (RIA) who specializes in retirement plans and work with them implement a few reasonable precautions.

The F-word does not have to be a dirty word anymore!

Brightscope, a popular financial information company that rates 401(k) plans, has something in common with Google:  They both know the value of data that the rest of us are all to willing to give away without thought.

As a 401(k) adviser, I am always looking at different tools available to help plan sponsors benchmark and compare their plan costs.  Here is something I think people should understand about Brightscope:  In my first conversation with Brightscope I learned that I could pay Brightscope a fee, give them real time data on a 401(k) plan (that is not publicly available on Form 5500,) and Brightscope will provide interesting feedback.

In my second conversation with the folks at Brightscope, we talked about my firm buying prospecting information from them to help build my 401(k) advisory business.

In conclusion: 

• I pay a fee and then give Brightscope valuable 401(k) data.
• Brightscope provides me with useful feedback.
• Brightscope turns around and sells my data to other people.

Is that a fair exchange – What do you think?

I have sympathy for the folks in HR.  Basically their job seems to be to handle everything the boss has no idea idea what to do with – while they fill in for the receptionist, clean the lunch room and fix payroll problems at the same time.

So it probably shouldn’t surprise me when my plea to review the 401(k) plan withers and dies on the vine.

Here’s the problem that most people in HR are all to familiar with:  Once they start chumming the shark invested water, by calling around about 401(k) options, they will be swarmed.  The feeding frenzy will consist of overly aggressive salespeople calling, writing, trying to get an appointment and sucking up all of HR’s time.

The Lesser of Two Evils:  So rather than chumming the water the boss and HR will decide to compromise.  They will call the current agent or broker on the plan and ask to see a few alternatives.  It’s not a great option because that current adviser has no real incentive to show the boss options that would truly lower the overall cost – and that advisers compensation.  Without competition, the current adviser will not be pushed to provide better service.  Think about it:  If the adviser comes back and says “I can lower your cost and I will start being proactive” wouldn’t the next question be:  “What have I been paying you for all these years?”

So we are back to square one:  Chumming the 401(k) waters for outside proposals.  Here a few ideas to help the folks in HR:

1. Set the ground rules:  Along the lies of:  “I will call contact you – don’t call/email/mail me”.  Failure to not follow the rules will result in immediate disqualification.
2. Set proper expectations:  When must the bids be submitted by?  Will you then interview finalists?  When will everyone be told who the winner is?
3. Use the same assumptions:  Every proposal must use the same number of plan participants, total plan value, expected future contributions, average account balance.
4. Fee Transparency:  Everyone must break the cost down for you the exact same way (using your form, not theirs).  Cost includes TPA cost, investment expense ratios, other assets based (sometimes called wrap fees) fees and a detail of who gets what for compensation.  Put that compensation is dollars and cents – not just a percentage.  You have a right to know how everyone is paid.
5. Service Standards:  Who does what?  What exactly is the adviser responsible for?  How much do they get paid (see question 3) for that?  What about the Third Party Administrator?
6. Investments:  With 20/20 hindsight everyone will show you great past performing investments.  Instead focus on the process.  Do you have both index and actively managed funds in each category?  How are the funds chosen?  When and why are they fired?  One stipulation – don’t get buried in fund choices.  Ask for the best 12 to 20 funds and why they are on the menu over other popular choices.

Happy fishing!

Let’s imagine for a moment that you have hired a suit and tie guy to help you with your 401(k) plan.

The funds that adviser puts on your 401(k) menu look good – names like Vanguard, T. Rowe Price, American Funds, Fidelity and Dodge & Cox.  Let’s also assume that you have made sure you covered all the bases for diversification:  U.S. stock funds, international funds, bond funds, target date retirement funds and a money market fund.

You’re confident you have the right mutual funds in place and the adviser promises to keep an eye on things for you.  Everyone is happy.

What no one has told you is that you can have the right mutual fund on the 401(k) menu but the wrong share class of that very same mutual fund.  Think of the different share classes as just different ways to pay for that well dressed adviser.

Example:  There are at least 12 different ways (or shares classes) to buy the American Funds Growth Fund of America.  Each option has a different cost and provides the adviser with a different level of compensation.  Here are the 12 options:

American Funds Growth Fund of America Class A (ticker symbol:  AGTHX)

American Funds Growth Fund of America Load Waived (ticker symbol:  AGTHX.lw)

American Funds Growth Fund of America Class B (ticker symbol:  AGRBX)

American Funds Growth Fund of America Class C (ticker symbol:  GFACX)

American Funds Growth Fund of America Class F1 (ticker symbol:  GFAFX)

American Funds Growth Fund of America Class F2 (ticker symbol:  GFFFX)

American Funds Growth Fund of America Class R1 (ticker symbol:  RGAAX)

American Funds Growth Fund of America Class R2 (ticker symbol:  RGABX)

American Funds Growth Fund of America Class R3 (ticker symbol:  RGACX)

American Funds Growth Fund of America Class R4 (ticker symbol:  RGAEX)

American Funds Growth Fund of America Class R5 (ticker symbol:  RGAFX)

American Funds Growth Fund of America Class R6 (ticker symbol:  RGAGX)

Cost and compensation vary widely depending on which of the above you have on your 401(k) menu.  Share class R1 has an expense ratio (which acts like a drag on investment performance) of 1.43%.  Of that, the adviser gets paid 1% or $10,000 for every $1 million dollars invested.  Share class R4 costs the plan participants 0.68% (the expense ratio) and pays the adviser 0.25% annually.  Remember:  It is the exact same mutual fund, just a different cost/compensation structure.

Do you have the right fund but wrong share class on your 401(k) menu?

Breaking up is hard to do, especially when you are breaking up with the most popular person in school:  American Funds Growth Fund Of America.  This mutual fund is found in most 401(k) plans and it is one of the largest, most popular funds out there.

Here is the problem:  The fund is described as a Large Company U.S. Stock Fund in most 401(k) plans, but if you look under the hood, you see it currently has roughly 16% (and is allowed to have up to 25%) of it’s assets invested overseas in non-US companies.

Is it fair to tell plan participants the Growth Fund of America is a US stock fund?  Is it fair to compare the Growth Funds performance to the S&P 500 Index which has 0.08% of it’s assets invested in foreign stocks?  Does the Growth Fund take the same amount of risk as the S&P 500 Index?

My answer to all of the above questions is NO.  Inexperienced investors (and advisers) often choose funds based on past performance.  Good past performance is only the starting point – you need to understand what drove that performance.  Ask yourself how the fund is invested compared to the index you measure it against.  Is that U.S. stock fund really invested like a global fund?  Is that bond fund up to their eyeballs in mortgage debt?  Is that mid cap fund overloaded with technology stocks?

Good performance by itself is not good enough.

Low cost index funds that promise you “average” returns can be a hard sell.  Here is how my conversation goes when explaining it to prospective clients:

KURT:  If you want to know the single biggest predictor of a mutual funds future success – just look at it’s cost.  For mutual funds that cost is known as the “expense ratio”.  The lower the expense ratio the better the chances of beating most mutual funds out there.  Cost is constant (you pay regardless of making or losing money) but good performance comes and goes.  Vanguard index funds are low cost and should make up the bulk of your 401(k) menu.

EXECUTIVE:  I agree cost is important, but I would be willing to pay more for better performance.

KURT:  You mean you would be willing to pay more for better past performance.

EXECUTIVE:  (Puzzled look…)

KURT:  No one knows what an investment will do in the future and past performance is such a horrible indicator of future performance, that the government even requires that I tell you that.

EXECUTIVE:  OK – cost is important but why index funds?  They almost guarantee you “average” returns by buying the entire market.  Shouldn’t we try to beat the market?

KURT:  A recent AARP study found that over 90% of drivers think they are above average.

EXECUTIVE:  (Puzzled look again…)

KURT:  Ask any stock broker if they have a method for finding above average mutual funds.  100% will think they do.  The fact is that over 70% of funds out there do worse than average.  That under-performance could cost you and your employees thousands over a lifetime.

EXECUTIVE:  I never thought that I would be hoping for “average”.

KURT:  Try selling “average”.

Things have been crazy lately with the stock market so what should you do?

It depends on where you are in your investing life…

If you are buying into  the stock market on a regular basis through your 401(k), you are in the “accumulation phase” of your investing life.  Like any other purchase, be happy when things go on sale like they did recently:  The sale gives you the chance to buy more shares of your mutual funds at a cheaper price.  When the market bounces back your steadfastness will pay off!

If you are recently retired, and are pulling money out/selling your investments  to live on, you are in the “withdrawal phase” of your life, and you have every reason to be concerned because the opposite rules apply:  If you sell when things are down (rather than buy) you are digging a hole that may be impossible to climb out of.

So like many issues of the day, those who are:   working verses retired / old verses young and rich verses poor may be rooting for opposite things.