In my last blog I discussed how a high cost retirement plan can cost employees a significant amount of their retirement savings. So what if you are responsible for the retirement plan at your organization — What questions do you need to ask to find a low cost plan that won’t saddle your employees with hidden fees?
1. What is the total cost of this plan including administrative fees, advisor fees (also known as ‘wrap-fee’ or asset management fee), and mutual fund fees?
Most employers look at administrative fees only. In the long-term the asset based advisor and mutual fund fees will comprise the vast majority of the costs. Most of these fees are hidden in that they are taken from the investment returns — most employees never know they are paying them. In general the fewer and lower the asset based fees in the plan the lower the overall cost to employees in the long-run.
2. Are there a wide variety of asset classes represented in the investment options?
Often employers get confused between the number of funds and the number of asset classes. A plan could have 20 different investment options from a variety of mutual fund companies but if all invest in large domestic companies the plan does not have diversification among asset classes.
Some key asset classes a plan should include are: Large Company Domestic Stock, Mid/Small Company Domestic Stock, International Stock, Bonds, Cash, and Real Estate. It is not necessary to include a large number of funds in the plan to achieve this goal. Nor is it necessary to have funds from multiple mutual fund companies.
3. Are your investment choices too complex?
In order to cover themselves and to offer a lot of choices, many plans are way to complex for most employees. Research on human behavior indicates that when presented with a large number of choices people will choose nothing or put everything in an investment that they understand.
The best 401k and 403b plans have very, very few choices. Reducing complexity through the reduction of the number of fund choices makes it easier for the employees to see the big picture and will increase the likelihood that they will invest in multiple asset classes.
The US Government defined contribution plan consists of only four (4)main investment options :US Stock Index Fund (Large/Mid/Small Domestic Stock), International Stock Index Fund (International Stock), Bond Index Fund (Bonds), Money Market (Cash). I think this plan is almost ideal. The only option I would add would be a Real Estate Index Fund.
Having a few investment options may upset the employees who like to “play the market” by trading in their retirement accounts frequently; however , this is not the purpose of the plan and reducing the number of choices will likely improve the investment choices of most employees.
4. What are the motivations and interests of the person who is advising you about your plan?
Many plan advisors are employees of an insurance company, stock brokerage, or mutual fund company. All of these people have a fundamental conflict of interest with you. They get compensated for selling you something so the advice that they provide you may not be objective. They may also neglect to explain all of the hidden costs involved with any investment recommendations they make. Many of the “free” services they provide come with a high long-term cost.
5. What type of fund is best for a retirement plan?
I almost always recommend that the plan choices be comprised of index funds. The major advantage of index funds is their low cost. The annual fee on an index fund may be over 1% less than a comparable non-index or actively managed fund. Since there is no difference in long-term performance between index and actively managed funds in almost all asset classes, the lower fees add up to higher returns in the long run.
6. How do you find people to help evaluate your current plan or set up a new one?
Hire an independent Fee-Only advisor to do the following:
- Evaluate your current plan (including all costs)
- And/or make investment recommendations for your current or new plan
- Write an investment policy statement for your plan
- Try and find an advisor who will work for an hourly or flat fee vs % of the assets managed.
- Provide employee education sessions to help them make good investment choices
Hire a plan administrator that: (this is the company that get the employee contributions and make sure they are invested as desired, they also work with you on compliance issues, and provide a website for the employees to see their balances and change their investment allocations. In bundled plans both the advisor and administrator role are handled by one company)
- Charges a flat or per-employee fee vs. an asset management fee
- Offers low cost index funds as investment options
- Your plan advisor may be able to recommend a plan administrator