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Plan sponsors, employees playing for higher stakes

Posted online

by Patrick J. Walsh

for the Business Journal

It's likely that your role as a retirement plan sponsor is more involved now than ever before. Defined contribution retirement plans, such as the 401(k) plan, have become not only more popular with small businesses, but also more comprehensive.

Today, the average 401(k) plan offers eight mutual funds, up from just two or three a few years ago, and some companies offer a hundred or more investment options.

The stakes for employees are getting higher, too. According to the Profit Sharing/401(k) Council of America's latest survey, the average participant account balance in a defined contribution plan exceeded $75,000.

Both you and your employees want to know that the investment options in your plan are meeting or exceeding your performance expectations. If they're not, you need to know how you can change the situation.

Employers who sponsor traditional defined benefit plans have long used investment policies to monitor the performance of their plans. Increasingly, defined contribution plan sponsors are adopting investment policies to guide their decisions.

Why an investment policy? In reality, all plans have an investment policy of sorts at the very least, a rationale for making plan decisions. More often than not, however, these policies are not formally articulated or documented. And, unfortunately for employees, most employers do not communicate to participants their decision-making process.

Every defined contribution plan, regardless of size, should have an investment policy. It can be as simple as a two-page document, or as detailed as a 100-page booklet. Employers of any size or in any business should have such a road map for managing a retirement plan.

Formulating an investment policy provides legal protection to an employer, tangibly demonstrating your effort to fulfill your fiduciary responsibility. The exercise of drawing up an investment policy may in itself prompt more rigorous thinking about investment selection, and lead to a better plan.

What to include. The documentation of your thought processes and decision-making rationale is the key element of an investment policy. Once this is articulated, you have a means of monitoring your plan over the years according to a consistent set of guidelines.

To start with, you might discuss the criteria used to select investment options. This might include parameters for the asset size or financial strength of investment companies whose mutual funds or investment options you're choosing.

You might detail what specific investment objective you intended to fulfill by offering each individual option. You might include reasons for selecting five or six options as opposed to 25 or 50.

More specifically, you might set guidelines as to how each investment option is chosen. For example, you might specify that a fund have above-average performance over a one-year, three-year or five-year period before you consider it as an option.

Or, you could specify the length of time a mutual fund under consideration must be managed by the same fund manager.

In your plan, you can also specify what investments you will not offer. You could determine, for example, that to minimize risk, the mutual funds you offer will not invest in derivatives or in emerging markets.

Your plan should also specify how you intend to monitor the performance of the investment choices you select. For example, you might establish the Standard & Poor's 500 as a benchmark for a stock mutual fund and agree to review the fund if it fails to meet or exceed that market index for two consecutive years.

It is important to document the steps you will take before you remove an investment option from your plan. Some companies establish a two-tiered system that allows for underperforming investment choices to remain available.

The first tier offers a core group of investments around which employees could build a portfolio that is diversified among the major asset classes. In the second tier, a second group of investment choices that may carry more risk, or in some way not meet the criteria of the first tier, is made available.

A two-tiered system allows a plan sponsor to put a first-tier investment that isn't measuring up to set standards on a sort of probation, removing it to the second tier, where it remains available to employees who wish to invest. It also allows a sponsor to offer investments such as sector or international funds that may carry more investment risk, but possibly more reward.

Lastly, your policy should establish how frequently investments will be reviewed for performance. In addition, you should consider how often you should review the policy itself, leaving yourself open to changes as market or economic conditions or the needs of your company change.

Help employees make decisions. Establishing an investment policy for your 401(k) plan or other defined contribution plan should be part of your overall effort to assist employees in making effective decisions about their plan participation and their investment selections. Talk with your financial consultant about how you can draw up an investment policy that will help you effectively carry out the mission of your company's retirement plan.

(Patrick J. Walsh is senior vice president and director of group employee services for Merrill Lynch.)


Every defined contribution plan should have an investment policy. It can be as simple as a two-page document, or as detailed as a 100-page booklet.[[In-content Ad]]


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