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Ok401k provides a wide range of retirement plan services for employers and their employees including but not limited to 401k vendor review, RFP comparison, employee investment help and fiduciary consulting. |
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| Volatile 401k Investment Choices You Should Never Offer To Your Employees! |
| Greetings!
Tis the season to be jolly and definitely the time for Santa to see what mutual funds have been naughty or nice. Do you have these potentially volatile and naughty investment choices in your 401k plan? If so, you may have a fiduciary problem brewing. |
Even though a 401k plan is a self directed benefit and the employees are responsible for selecting their own investments, employers as fiduciaries still have a responsibility under ERISA to select and monitor appropriate investments. That means not offering bridges for sale in Brooklyn, Enron stock or sub prime mortgage backed securities as 401k investments choices for your employees. Especially when you look at the way most participants manage their 401k. Past studies reveal that most employees don't pick a diversified portfolio and never even rebalance it after enrolling. So, if a particular 401k investment choice melts down or causes havoc with their portfolio there may be "hell to pay" in the future for the employer. Farther down in this story I mention a few "niche" sectors that may just drive your employees crazy in volatility. For example, one of the ways the Department of Labor effectively prosecuted Ken Lay of ENRON was because of the collapse of the ENRON stock inside the 401k plan. Enron's 401k committee was approving the stock as an appropriate investment choice inside the 401k while everyone on the board were selling ENRON stock like it was a hot potato! Can you spell jail time? Are you on your 401k committee?
When I was first introduced to the 401k business back in the early 90's, I always thought it was odd that we required the average "Joe Blow" American worker to suddenly become a Wall Street Wizard and know precisely how to select their own funds. As well all know, 401k plans have rapidly surpassed Defined Benefit Plans (guaranteed profit sharing plans by corporations). These old time "smoke stack" industry retirement plans were promises from an employer to an employee that if you worked for the company most of your working life, this company was going to pay you an income for life based on a formula. In order to satisfy this promise, the employer (usually a pension committee) was responsible to select highly trained actuaries and a fund manager that managed the money (not the employees). These professionals operated under strict federal pension laws. These pension plans have been disappearing faster then your local mortgage broker. Remember when it seemed like yesterday that your brother in law wanted to refinance your mortgage for you? Where did all these brokers go? In addition to real estate brokers, the real estate industry both commercial and residential has gone "poof" in most of the country.
Back to the old time profit sharing plans. Now we have replaced these pension guarantees from corporate America with the more inexpensive 401k plan system that have no guarantees at all. For some reason, employers in America both big and small over the past 27 years thought they were off the hook and don't have to worry now about their workers any more or what funds are offered in the 401k plan. Their reasoning was that the insurance or mutual fund company that managed their 401k plan knew what was good for them and their employees. Employers also relied upon commissioned sales people who they thought were looking out for their best fiduciary interests. Wrong! Never before has their ever been such a growing powder keg of liability for employers. Because of the current melt down in the economy and stocks reducing workers 401k portfolios to 201k's, employers have a fuse that may have been already lit because of volatile fund choices and high hidden fees inside of their 401k plan. Employers simply have been faked out about who is supervising and reviewing the funds on their 401k plan. Is it their insurance agent, stockbroker, mutual fund or insurance company 401k vendor? Who is watching their back side on their fiduciary responsibilities for the 401k investments offered?
One of our colleagues who is a successful group health insurance agent but really not trained as a 401k advisor asked Ok401k to take a look at the fund line up of his newly acquired 401k plan currently with Principal as the provider. The plan had one of Principal's own proprietary Real Estate separate accounts choices and unfortunately we discovered this particular real estate choice had a "restriction clause" which Principal activated on September 26. Like many real estate choices, this investment fund was suffering from the real estate market "run on the bank" we were all seeing across the USA. Redemptions were coming in from 401k participants faster then rats jumping from a sinking ship. Principal said the fund was "experiencing liquidity issues caused by a marked slowdown in commercial real estate sales at the same time that cash flows out of the Separate Account have outpaced new contributions into the account." This was possibly a wise decision for their real estate manager to temporarily stop redemptions because obviously they could not liquidate good positions in real estate to satisfy all the redemption requests from 401k participants. Though, this may be a good thing for Principal but, was it good for 401k participants that had this choice in their 401k plan? Principal basically said to participants that if you wanted to redeem your money (move it from one fund to another); you had to be in a "QUEUE, much like what you and I experience when we get in line to buy the latest hot concert tickets. So, the timing of the movement of an employee's money was also in limbo. Question out there for all of you that take pride in the funds you offer in your 401k plan; is any investment choice in a 401k plan an appropriate choice for your employees if a participant may be potentially blocked from moving their own money in a timely manner especially if the fund is losing money? Is this a fiduciary problem for the employer if their employee is restricted for even one day from liquidating positions inside any fund choice and moving to another fund? We think attorneys out there would be very curious about this restriction along with the Department of Labor.
Now what makes this even more interesting is Principal is allowing 401k participants to continue to invest more of their money into this real estate choice while they are still restricting participants from moving their money out in a timely manner. It's sort of like the rock group Eagles singing Hotel California for your 401k money. You can check in but you can't check out. In fairness to Principal, they are allowing beneficiaries to get access to their money immediately if they die or become disabled. Cool. By the way, this commentary is not on the performance of this separate account. It has done well since it's inception.
For most people, a real estate mutual fund is the best way to invest in real estate securities if you don't have a million dollars. Ever try to invest $100 dollars in a shopping mall? Real Estate funds are a great way to do this for anyone wanting to be like Donald Trump on a two bit budget. But for a 401k plan it may be a little too volatile. There's a surprising amount of variety in real estate funds choices. Besides Principal's real estate 401k choice there are many other great real estate selections. For example, CGM, AIM, ING and JP Morgan all have fine fund choices. Though as of September, 2008 many are experiencing a truck load of hurt year to date! If you're thinking about wading into REITs or real estate funds outside of your 401k plan we think they are a great choice unless of course you have the "Hotel California" clause. If you do though invest in real estate, we suggest you take your time because as the economy slows dramatically, real estate funds will hit your portfolio like an OSU or OU Linebacker. Even if this practice for insurance or mutual fund 401k vendors that Principal is exercising is a usual and customary practice specific to real estate funds, it ain't pretty for your 401k participants to be restricted in any way! In my 12 years of 401k plan consulting, we have never seen employees restricted from moving their money from a fund choice unless they were in a Guaranteed Contract (GIC's). And, most employers and 401k participants understand those typical insurance company restrictions.
There are other 401k fund choices that simply aren't long-term investments. Sector funds, which specialize in small sections of the market, are not long term investments. Neither are funds that specialize in a small region of the globe. Nor are emerging-markets funds. They were made to be watched like sailors on shore leave with the Captains Visa card. These investments outside of your 401k plan were just never designed to be allowed within 10 miles of a 401k plan. In fact, a buy-and-hold approach makes little sense for many investment choices outside of an IRA or 401k. You should have your exit strategy planned when you first plunk down your money. First of all, Ok401k needs to make a clear understanding here about what are appropriate fund choices inside a 401k plan. Diversified mutual funds, such as broad-based U.S. stock funds, really are long-term, buy-and-hold investments, even though they have been stomped lately. But assuming that a broadly diversified stock portfolio that is managed appropriately will gain in value over 10 or 20 years isn't exactly your grandfather's pipe dream. Good returns aren't guaranteed, because if they were, you'd get the same returns from stocks as you would from any ultra safe investment, such as a CD guaranteed by the FDIC. Nevertheless, the Las Vegas odds are generally in your favor if you bet that stocks will outperform bonds and money market funds over the long term.
Now, back to "niche" fund choices outside of your 401k plan. The longer you hold a specialized niche fund, the more likely you are to have a catastrophic loss of 50% or more. And in most cases, all the hot returns in previous years aren't enough to compensate for the dreadful losses your employees may experience. In a 401k plan these enticing "diva" funds can act as big flirts in getting your workers to put some money down based on a hot year of getting 30% or 40%. But wait till next year! The flirt will turn into an ugly duckling.
Let's take a look at precious metals funds, which invest primarily in gold-mining stocks. Notice all the TV commercials lately for Gold? From 2005 through 2007, the average precious metals mutual fund would have turned $10,000 into $21,207. This year, however, the funds have plunged along with gold prices. The average precious metals fund is down 59.2% this year, turning your $21,207 to $8,652 - a 13% loss on your original $10,000 investment. Yet, amazingly at Ok401k we visit with many employers who unfortunately put these specialized choices inside their employee's 401k plan simply because the day trading executive down the hall is yelling he has to have commodities in the 401k because "that is how you make money." Yeah, right....and Mr. Scrooge at Christmas time was a great philanthropist! 401k plans are not made to be day trading vehicles.
Emerging markets also tend to fall apart with distressing frequency. A fund managed by ING that invests in a specific European country gained 30.7% last year, but has plunged 74% this year. In fact fund choices in the Emerging Market category are down approximately 60%. Some of these emerging market countries like Russia have their economics totally hooked on Oil. The former Communist giant's fortunes seem to be melting down like Texas Longhorn fans falling to their knees with the BCS football playoff announcement. How would you like to hear one of your employees say that one of their 401k investment choices lost 74% this year? Think you may have a fiduciary problem? That is what you will get from a sector fund like Emerging Markets. They will love you and leave you in a heart beat. Now, if you like to speculate outside of your 401k plan and there's nothing wrong with that, then feel free to invest in highly specialized funds. But make some ground rules for when you want to get out okay?
Real 401k consultants (not your typical life or health insurance agent) say that employers working with a 401k advisor should construct a selection of funds to offer to their employees that adheres to a strategy of hold em till Cuba wins the Olympic Gold Medal in Ice Hockey and your property-casualty insurance agent resolves a claim in your favor with a big fat check. One of the ways to dodge this whole volatile fund problem is to offer Target Date Funds or diversified portfolio's managed by a professional for your employees. But, that is another story in our next newsletter. Call Ok401k if you want a 2nd opinion and review of your 401k investments. Are they suitable for your employee's long term investment needs or are they flirting with the hot floozies down the street?
For informational purposes only. Returns are not
guaranteed and losses are possible. Past returns are not
indicative of future returns. Neither Terrence Morgan,
OK401K, Wilbanks Securities Advisory or Wilbanks
Securities are responsible for decisions to invest.
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| Your 401k Bill of Rights
All employers deserve these rights. (What your agent and 401k vendor owe you.)
The Employee Retirement Income Security Act (ERISA) requires that fiduciaries of employee benefit plans (that is you the employer) administer and manage your 401k plan prudently and in the interest of the participants and beneficiaries. In carrying out these responsibilities, plan fiduciaries often rely heavily on professionally trained 401k advisors like Ok401k for help. A recent report by the staff of the U.S. Securities and Exchange Commission (SEC) released in May 2005, however, raise serious questions concerning whether some insurance agents, stockbrokers and consultants are fully disclosing potential conflicts of interest that may affect the objectivity of the advice they are providing to their pension plan clients. For example, a stockbroker or insurance agent and bank representative may have their own proprietary funds they want to sell inside your 401k plan. Obviously these 401k vendors selling agents may be able to make more money selling their own proprietary funds inside your plan.
The gold standard in the future used by quality employers when screening 401k advisors is to hire an Investment Advisor Representative (IAR) who will sign an agreement stating they will be a co-fiduciary on your 401k plan. Under the Investment Advisers Act of 1940 (Advisers Act), an investment adviser representative providing consulting services has a fiduciary duty to provide dis-interested advice and disclose any material conflicts of interest to their clients.
Ok401k meets regularly with potential clients. We are always amazed about the many groups we meet who seem unaware of what their basic fundamental fiduciary responsibilities are. Your 401k mutual fund, insurance company and/or bank is a vendor. Vendor's always need supervision. If you don't have the professional training to supervise your 401k, smart employers hire a fiduciary advisor to make sure their 401k vendor is giving you and your employees the best bang for your buck. Therefore, Ok401k came up with the following "Employer 401k Bill of Rights."
Your Employer 401k Bill of Rights
Article 1. The Right To Real 401k Investment Advice. As my consultant, please provide my employees with real investment advice and investment help not investment education which is as simple as handing out enrollment kits and wishing my employees good luck. My secretary and I can do that. (Investment Advisors are able to provide dis-interested investment advice to participants. We do not sell proprietary investments. There is no incentive to sell one product over another. Registered Representatives, insurance agents and stockbrokers may have another agenda. Only an Investment Advisor Representative can sign an agreement with an employer accepting co-fiduciary responsibility. Ask your advisor if they are registered with the SEC or a state securities regulator as an Investment Advisor Representative and will sign a co-fiduciary agreement. If so, they must provided you with all the disclosures required under those laws (including Part II of Form ADV))
Article 2. Please be unbiased in recommending 401k vendors. We don't want plans that you can make more money on certain funds or vendors. (This is a common problem in the 401k business. Agents, bank representatives and stockbrokers can make more money recommending certain investments or 401k providers).
Article 3. As my advisor, please review my 401k investments quarterly and report to me annually to satisfy my fiduciary responsibilities. Our investments must be in the top 25th percentile as compared to their peers. (Some "lazy" advisors rely upon the investment data from the 401k vendor and do not 2nd guess the 401k vendors. Good 401k advisors compile their own data and perform their own research on the 401k investments in your plan. Allowing your 401k vendor to provide you with the annual review data may result in mediocre or poor performing funds being left in your plan rather then being replaced.
Article 4. As my advisor, please provide me with an Investment Policy Statement (IPS). This IPS will enable me to have important written criteria in place that guides me and my 401k committee when reviewing our 401k plan. Not having a customized IPS is like trying to build a new sky scraper without a blue print. Don't you deserve a custom designed IPS instead of a "cookie cutter" IPS?
Article 5. The right to fair disclosure of the total cost of participation. As my advisor please provide me with a complete disclosure of all investment fees my employees incur in the 401k plan. You have a fiduciary responsibility to know exactly all fees in your 401k plan. Some advisors can get paid more in commissions by having a wrap fee on top of your investments . Insurance companies either put this fee on top of your funds or slip you in a higher share class. You have a duty to know those fees and your advisor should be forthcoming. Typically these extra wrap fees are negotiable.
Article 6. Do not allow my company and employees to be put into a 401k contract with a vendor that has surrender fees. This "a-sleep at the wheel" consulting is soooo 20th century. We at Ok401k usually see unprofessional advisors allowing their client to sign silly 401k contracts like this. If you are in a 401k vendor contract like this, fire your 401k advisor and hire a real one. Ok401k has a way to help you get out of these contracts.
The six articles up above are your basic 401k Employer Bill of rights. We have more. Call us and ask us what the other four (4) Bill of Rights are. | |
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Merry Christmas and Happy New Year. Call us at (405) 603 4986 if you would like a no cost no obligation review of your 401k plan fees and investment choices.
Sincerely,
Terrence Morgan, AIF
President
Ok401k, Inc.
Terrence Morgan, AIF
terrencemorgan@ok401k.com
Ok401k, Inc.
(405) 603 4986
Terrence Morgan, AIF is a Registered Representative of and offers securities though Wilbanks Securities, Inc. Member FINRA & SIPC. Securities activities supervised from Wilbanks Securities, Inc. at 4334 Northwest Expressway, Suite 222, Oklahoma City, Ok. 73116. (405) 842 0202. Fee based through Wilbanks Securities Advisory. Fiduciary status requires employer being given WSA ADV form Part II and a fee agreement must be established.
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