Financial Planning Focus – Your 401(k) Plan—Things You Need to Know

AA recent Washington Post article called to task no less than Warren Buffett with regard to the investment choices available to his employees in their retirement plans. Mr. Buffett is a strong proponent for passive index investing over active management. So, you would think that his company’s retirement plan would offer primarily low-cost index funds, or at the very least, be consistent in the pricing structure associated with the various plans. That doesn't appear to be the case.

In Mr. Buffett’s defense, the business subsidiaries under Berkshire Hathaway each have their own investment lineups and Mr. Buffett doesn’t participate in the selection process. However, the Washington Post article details considerable variations in availability of index funds and fees associated with both active and passive fund selections. While these are not decisions made on the corporate level, but rather by each subsidiary, you would think that some amount of consistency would apply.

So, what does the variability of investment options for Warren Buffett’s employees and the apparent disconnect from the iconic investor’s ideals mean for you? As a participant in an employer-sponsored retirement plan, you really should know how the investment options you have were selected and what fees you are paying for the plan. Fee disclosure statements do very little to illuminate the process or provide transparency for all plan fees.

Mr. Buffett is correct that passive index investments are often the better option for retirement plan participants. Index funds represent market returns and low costs, which are desirable with regard to meeting long-term savings goals. That’s not to say active management can’t play a role in retirement savings. However, the added value of active funds must be determined during the selection process. Here is an example:

• A plan offers three T. Rowe Price large cap funds.
• The options are an S&P 500 index (TRP Equity Index), a large value (TRP Equity Income) and a large growth (TRP Growth Stock) fund.
• Over the time period March 30, 1990 through April 11, 2018, both of the actively managed funds outperformed the index fund. This suggests that T. Rowe Price might have some good actively managed options that offer additional value to participants who want to build a diversified portfolio around an index fund.
• However, if the actively managed funds selected were higher cost advisor shares, only the Growth Stock fund would outperform the index over the longer time period. 
• The difference in cost between the retail shares and the advisor shares is 0.27 percent, on average.
• With either share class, the index fund outperforms the value fund and underperforms the growth fund over shorter time periods.

This example illustrates a few things. First, it shows that there are actively managed funds that can outperform a passive index fund over time. Careful review and selection of these funds is critical and should be delegated to a plan fiduciary with the skills and experience to help guide this decision. Second, it shows that an awareness of direct and indirect costs is critical in making appropriate fiduciary investment decisions. In this example, an employer selecting the Advisor share class for the active funds would potentially have lower direct plan-related costs, but indirect costs to the participant would be higher. In other words, you may not see a direct cost deducted from your balance, but the selection of a specific investment class could be resulting in higher internal fees, which impacts performance.

So, whether or not your 401(k) or similar company-sponsored retirement plan has index funds is important, but maybe not as important as the selection process associated with the plan investment options. From a fiduciary perspective, it is important that the investment lineup is suitable to meet the retirement needs of the average participant.

If you have any questions about your own 401(k) plan investments, please feel free to contact us and we will be happy to review your plan’s lineup, fees and your personal account. And if you are a fiduciary of a plan that has not been reviewed in the past few years, with regard to suitability of investments and fee structure, our retirement plan consulting service can help you meet fiduciary requirements.