Corporate retirement plans, such as popular 401(k) plans that make up the vast majority of defined contribution plans, have been whipsawed by volatile financial markets over the past couple of years. The stock market, as defined by the Standard & Poor’s 500 Index, plummeted 37% in 2008 to recover some of this lost ground by posting a nearly 27% return last year. Global markets have been even more uneven and formerly boring bond markets have been faced with uneven interest rate outlooks and questionable credit trends.
Helping employees navigate such uncertainty as they save for retirement is not an easy matter even when markets are stable. Regardless of the mood of the market, below is an overview of the two most important matters when choosing a 401(k) provider to run an employee plan.
A recent article in the Financial Times detailed that most plans should simply focus on passive investment vehicles, which is advisable for both equity and fixed income assets. Passive indexes simply seek to match the market return, be it the S&P 500 for stocks or the Dow Jones Corporate Bond Index.
A criticism of this approach is that it guarantees underperformance once management fees are subtracted, but many studies have shown that active managers in aggregate have a terrible track record at beating the market over the long term. This is because many portfolio managers are “closet indexers”, as the article defines it, meaning they claim to be actively managing their portfolios but hold many of the same stocks as are held in the index, which makes outperformance more a matter of luck, not investment skill.
Fees also make a difference in that they reduce total returns. Again, passive investments charge the lowest fees and active managers for the most part charge excessive fees given their inability to outperform benchmarks. Fees are especially important for bond funds these days given that interest rates are so low. To demonstrate how important fee considerations are, another Financial Times article in the same financial management survey this week highlighted a number of retirement plan lawsuits where plan participants accused their underlying plans of charging excessive fees. For more details on 401(k) plan fees, the U.S. Department of Labor provides a further look.
Overall, the best advice may be to focus heavily on passive management and seek out active managers that aren’t closet indexers to try and achieve some outperformance while keeping a tight lid on overall fees.