Choosing a Retirement Investor
When picking an investment advisor, many plan administrators (e.g. employers) ask about firms’ fees, available funds, and participant outreach, but they often miss another important factor: the investment selection process.
Even though investment advisors commonly charge a fee based on assets under management, many do not actively manage the assets. Instead, they serve as an investment gatekeeper and robotically offer similar sets of target date funds [hereinafter TDFs] to every plan.
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How Target Date Funds (TDFs) Work
TDFs primarily exist to help people plan for retirement. The TDF accomplishes this goal over the life of the fund by initially investing in riskier assets and then gradually shifting investment towards low-risk, stable investment options. People commonly refer to this transition as a glide-path.
Potential Problems with TDFs
TDFs on their own are not the issue. Rather, problems stem from how and why investment advisors use them.
Cost of TDFs
TDFs are generally more expensive than other investment options. This is partially because of the added management cost incurred by the company offering the TDF. Instead of taking this into account, many investment advisors blindly offer TDFs to participants and then charge a fee based on assets-under-management, even though they have essentially delegated asset management to the TDF.
Generic Investment Strategy
TDFs do not always balance risk appropriately because they use the same glide path for everyone, even though no two investors are the same. For example, some people might want to stay in equity longer because they have sources of retirement income outside of the plan, but if they only have access to TDFs, then they are stuck with the one-size-fits-all strategy.
This robotic process, while common, can increase legal risk in retirement plans. This is because plan sponsors must act “with the care, skill, prudence, and diligence[,]” which includes a duty to monitor and replace existing investments.
This past May, a federal court of appeals confirmed this in a ruling against a plan sponsor. In this case the plaintiffs claimed that the sponsor violated it’s “prudent man” standard of care by
- paying unreasonably high investment fees
- offering investment options that were more expensive and worse performing than available alternatives
- retaining multiple options in the same asset class and investment style.
The sponsors claimed their decision to offer participants a self-directed brokerage account and 78 different funds protected them from liability. The court disagreed and said it is incorrect to assume that offering, “a meaningful mix of and range of investment options insulates plan fiduciaries from liability”.
The court chose instead to evaluate the “fiduciary’s performance by looking at process rather than results”, and said “[t]he law expects more than good intentions. A pure heart and empty head are not enough.” Ultimately, the court decided that merely offering a diverse menu of funds does not protect sponsors from suit and allowed the suit to continue.
Process is More Important than Substance
While this result may come as a shock to many in the retirement community, multiple cases, Department of Labor regulations, and basic concepts of trust law state that fiduciaries must do more than apply a one-size-fits-all solution. Plan sponsors need to work with providers who use customized processes tuned to each plans’ needs. This is because courts mainly look to these processes to determine if a fiduciary acted prudently, and multiple courts have held that merely offering a wide range of investment options is not an inherently prudent decision.
Process Provides Protection
Ideally, an investment advisor would provide each client with an investment policy statement that formalizes the process the advisor will use to select, monitor, and remove funds from each plan’s investment menu. These statements are useful because they increase transparency, help the sponsor understand the investment process, and provide greater protection from lawsuits than a robotic alternative.
Is Your Investment Advisor Protecting You?
If your investment advisor has not provided you with a formal investment policy statement, ask them to put their asset selection and monitoring process in writing. If they refuse to or are unable to explain their process, then how can you expect to convince a jury that choosing to offer one investment option over another was a prudent decision?
At ERISA, our independent investors are not backed by firms who have a vested interest in your retirement funds. We have the ability to choose a retirement plan that’s right for each individual without bias. Want to learn more about our investors?
The Department of Labor has created free resources that can help plan sponsors make more informed decisions when selecting vendors and considering TDFs. We have included links leading to these PDF resources below.