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Achieving a Successful Investment Experience

Joshua P. Itzoe, CFP®, AIF®

Achieving a successful investment experience is the goal of every retirement plan participant.  Reaching this goal allows the employee to accumulate sufficient assets to support their income needs in retirement, helps them minimize or even eliminate the stress they feel about the investment process, and allows them to stay focused on the long-term rather than worrying about short-term performance.

Your job as an institutional fiduciary is to put your employees in a position to have a successful experience by making prudent decisions from a plan design and investment selection standpoint.  By doing so, you are able to help your participants benefit fully from the wealth creation that comes from long-term market appreciation.

We believe that capital markets work effectively and deliver attractive rates of return over time.  A successful investment experience is one that enables the investor to achieve market rates of return.  This approach is in contrast to most strategies that try to "beat" or "outperform" the market.  There are significant amounts of research showing this "active" style of investing to be extremely difficult to do over time.

The cornerstone of this philosophy is helping your participants focus on the elements they can control rather than on those they cannot.  We believe there are four aspects of the investment process that are within an investor’s control:

  1. Being disciplined
  2. Being globally diversified
  3. Controlling costs
  4. Managing taxes

Unfortunately, most investors tend to focus on things that are not in their control which leads to an unsuccessful investment experience.  The chart below highlights a study done by Dalbar on investor performance from 1986-2005.  As you can see, during a period of excellent market performance, the average stock fund investor failed to earn rates of return anywhere near the market.

Mistakes Fiduciaries Make, Part 1

Most institutional fiduciaries fail to focus on the elements within their participants control when developing the Investment Policy for their company’s plan.  The first step in creating an effective Investment Policy is to identify which asset classes should be included in the plan.  Studies have shown that long-term performance comes primarily from portfolio structure (which asset classes to utilize) as opposed to security (or fund) selection and market timing.

Capital markets are composed of many classes of securities, including stocks and bonds, both domestic and international. A group of securities with shared economic traits is commonly referred to as an asset class. There are several asset classes, all with risk and return characteristics that are distinct from one another. Your participants can benefit by combining these different asset classes in a structured portfolio.

A full range of asset classes includes small and large stocks, domestic and international, value and growth, emerging market countries, global bonds, real estate, and even commodities. Because the asset classes play different roles in a portfolio, the whole is often greater than the sum of its parts. Participants have the ability to achieve greater expected returns with less price fluctuation and more consistency than they would in a less comprehensive approach.

Structuring an investment strategy around specific asset classes lends purpose to the investment selection process at the plan level as well as the participant portfolio level. Rather than analyzing individual securities or mutual funds, investing becomes a relatively simple matter of deciding how much stock to hold versus bonds, and how small or large, and value- or growth-tilted the stocks should be.

Mistakes Fiduciaries Make, Part 2

Fiduciaries tend to make mistake #1 because they often allow service providers with significant conflicts of interest dictate the process for them, rather than utilizing an independent fiduciary to help them structure and drive a formal evaluation process.  Many fiduciaries rely on their broker/advisor or 401k provider (in many cases a mutual fund company) to recommend a proposed mutual fund lineup during the sales process.  Unfortunately, this presents two significant challenges for the institutional fiduciary to overcome.

First, these service providers usually do not serve in a fiduciary capacity to the plan and have undisclosed conflicts of interest that color the objectivity of their recommendations.  Lack of fee transparency and disclosure with regard to revenue-sharing makes it very difficult for the plan trustee to determine exactly how much the plan costs and who is receiving compensation.  This represents a breach of fiduciary duty for the plan trustee.  If a broker/advisor or 401k provider is compensated by the mutual funds that are available in the plan, there is the risk that they will recommend funds that provide the most compensation (usually with higher expenses) as opposed to the funds that are best for the participants.  Without serving in a fiduciary capacity, these service providers have no obligation to disclose these facts nor recommend what is best for the plan.  Unfortunately, this does put the institutional fiduciary at risk.

Second, it’s nearly impossible for the institutional fiduciary to make a clear comparison of fund recommendations from different providers.  For instance, suppose a plan trustee was mainly focused on fund performance for the previous 12 months and asked two mutual fund companies to put forth their recommended mutual fund lineups.  Let’s also assume that international stocks had performed exceptionally well over this period – much better, in fact, than U.S. stocks.  Finally, assume that fund company A proposed an equity lineup consisting entirely of U.S. stock funds while fund company B proposed a lineup that included several international stock funds.

It’s likely that fund company B would appear much more attractive because the performance of their recommended funds included an asset class (international stocks) that had great recent performance.  Does that mean that fund company B’s recommendations are going to perform better over the next 12 months, 2 years or 10 years?  Not necessarily.

Benefits of an Independent Fiduciary

In the example above, the institutional fiduciary is skipping the first step in the investment selection process and putting the proverbial cart before the horse.  To provide a more accurate comparison, the fiduciary should first identify the asset classes that should be in the plan and then require both fund providers to present their fund recommendations for each asset class.  Next, the fiduciary should consider important factors such as expense ratios, style drift, turnover and performance of the funds proposed for each asset class to make their selection.  Doing so provides for a more meaningful comparison between the proposed options.

The fact is that most institutional fiduciaries and their service providers are poorly equipped to lead a prudent investment selection process, either because of insufficient knowledge or conflicts of interest.  The solution is to hire an independent advisory firm such as Greenspring Wealth Management who serves in a fiduciary capacity with expertise in both fiduciary governance and investment consulting.  By doing so, the institutional fiduciary will receive truly objective advice, make prudent investment decisions that will benefit their participants and ensure that a sound fiduciary governance process has been implemented and followed.

To learn more about Greenspring's retirement plan consulting services, click here.

The information in this article is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, and does not purport to be complete and is not intended as the primary basis for financial planning or investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor.