How to Choose the Best Options For Your Company's 401(k) Plan: Fund Selection and Diversification
A good 401k plan starts by having a lineup that helps employees build good portfolios. 'Most plan providers these days have an open architecture; they have hundreds if not thousands of funds to choose from,' says Chen. You want to offer at least 20 different investment choices. 'That gives enough coverage among the major asset classes employees would need to invest in to build diversified portfolios.'
Include the core asset classes: stocks, bonds and cash equivalents such as money markets along with real estate and international holdings, mutual funds, and exchange traded funds. Offer further breakdowns within the asset classes such as growth stocks, value stocks, small, mid, and large cap stocks, government bonds, corporate bonds, municipal bonds, short-term and long-term bonds, emerging market stocks, and emerging market bonds. Don't overlook alternative asset classes such as precious metals, commodities, and some other investment that doesn't move in the same direction as the stock market, says Ivory Johnson, director of financial planning at Scarborough Capital Management, a boutique wealth management firm in Annapolis, Maryland, which manages company sponsored 401(k) plans from Fortune 500 clients to small businesses.
'The way you reduce volatility is to have asset classes that move in different directions,' says Johnson. 'Large caps, mid caps and small caps go up and down around the same time although at different rates. The key is to have sufficient diversification. You can't have a diversified portfolio if all you are offering is three asset classes and maybe an international fund.'
Also consider default options such as target date funds, retirement managed funds or balanced funds. Target date funds automatically adjust the weightings of asset classes within the portfolio overtime to become more conservative as the employee gets closer to retirement age. To hedge against inflation, more plan managers are adding Treasury Inflation Protected Securities (TIPS). The principal of TIP increases with inflation.
IBM provides investment options in four different tier groups. Tier 1 is a broad fund category that includes target and risk-based funds for participants who don't want to get too involved in the selection process. Tier 2 is custom funds representing US equities, non-US equities, bond funds, real estate investment trusts and other broad asset classes. Seven funds are available in this category. Tier 3 is standard choice, which has a narrower focus of large cap, mid cap and small cap funds, growth and value funds, and IBM company stock. There are 11 funds in this category. Tier 1, 2, and 3 are IBM's core options, says Adams. 'None of these are mutual funds but rather commingled trusts or separate accounts. Most of these funds are passively managed index funds.' Given IBM's size, Adams notes the company is able to get extremely low expense ratios. Tier 4 is a mutual fund category that gives participants access to actively managed funds from brand name companies. 'This lets employees go into sub sectors like foreign funds or convertible bonds,' Adams says. 'We have 165 funds within that category.'
Dig Deeper: Study: 401(k) Plans Mismanage
How to Choose the Best Options For Your Company's 401(k) Plan: Employee Education and Financial Advisory
A little education can go a long way in helping employees better manage their 401(k) accounts. It is always good to get advisors to come in and provide financial education for your employees, says Johnson; they can be affiliated with your plan provider or an outside firm. Doing so could increase employee contributions as well as protect the plan sponsor from litigation, Johnson adds. 'When it comes time for them to retire, if the market is down employees are going to look for someone to blame; they aren't going to want to take personal responsibility for managing their portfolios. So, the best way to limit your liability is to provide employees access to third-party advice and to hold seminars that explain the various investment options in your company's 401(k) plan.'
In addition, consider features proven to add value like financial engines that automatically rebalance a portfolio's asset allocation to help reduce risk. For instance, as an employee gets closer to retirement age, risk is reduced by selling off equities and buying more fixed income investments within the account. Some investments have built-in rebalancing such as target-based funds.
IBM provides access to financial engines that run retirement checkups. Using web seminars and modeling tools employees can estimate what retirement livelihood they are looking for and receive advice on how they should invest their retirement funds. IBM also offers money coaches through its MoneySmart program, allowing for unlimited one-on-one sessions between plan participants and independent non-commissioned financial advisors.
Employees can seek advice on just about any aspect of their financial lives and assets outside of their IBM 401(k) accounts. 'These counselors are very familiar with our plan and can address various financial situations, whether that is planning for retirement, saving for a child's college education, or dealing with caring for an elderly parent,' says Adams.
Dig Deeper: 401k Retirement Calculator
