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any companies who have a
401(k) plan want it to be suc-
cessful but just don't know how
and don't spend the time to find out.
They might depend on an advisor who
is versed in financial products but
doesn't specialize in 401(k)s or depend
on a direct relationship with a vendor.
There is a general discontent among
plan participants, but it's blamed on
"the market" or "the economy."
There are three keys to 401(k) success
that will help your clients to maximize
the performance and effectiveness of
their plans, and you may be surprised
at how much impact they can have.
1. Make sure that the plan has an
Investment Policy Statement (IPS).
This document defines the parameters
for prudently identifying, retaining, and
monitoring the investments in your
plan. If you ask your clients for a copy,
you may be surprised to find that they
don't have one or, if they do, it's not
being followed.
The IPS will list the specific criteria for
selecting a fund in the first place,
including historical performance, man-
ager tenure, and style consistency. If a
fund is competing in the large cap
growth space, for instance, are the
managers actually buying large cap
growth stocks? The IPS will also have
criteria for risk adjusted performance
where calculations for Alpha and
Sharpe Ratio can help determine the
likelihood of future success. All of these
factors are then compared to other
funds in the same category, which ver-
ifies that the fund is among the "best in
breed" among its peers.
It's important to note that best practices
in this area dictate that this methodolo-
gy should be independent and not part
of a vendor-provided scoring system.
When the vendors' own scoring system
leads you back to its proprietary fund
list, it's prudent to get a second opinion
from an independent source, since it's
unlikely that any one fund family/
vendor will have all the best funds.
Next, the IPS should provide a monitor-
ing system to ensure that the high-
quality fund line-up you chose in the
beginning will continue to perform well.
With most funds, it's just a matter of
time before there is a management
change, a drop-off in performance, or
some other event that makes the fund
unattractive. A typical monitoring sys-
tem will track the progress of the fund
on at least a quarterly basis and show
you if a problem is developing. Poorly
performing funds will migrate to a
"watch list" so that they can be moni-
tored more closely, and there can be
discussions about possible next steps.
Lastly, there should be criteria for
removing a fund. Usually this involves
a pattern of poor performance over
several quarters, but it can also be
sudden, in the case of a manager
change or other event. If you as a CPA
can make sure that your clients each
have an IPS and can help them follow
through to this last area replacing bad
funds you can make a huge differ-
ence in their plans.
2. Establish an Independent
Benchmarking System.
Once the IPS is in place, you will
want to establish an independent
benchmarking system. Benchmarking
has been around for years in the
human resources area, and most of us
have been through a process of being
evaluated and benchmarked for per-
formance reviews and raises. In recent
years, this has also emerged as a tool
to quantify that trustees are indeed act-
ing "solely in the best interests of par-
ticipants" per ERISA.
In the 401(k) world, benchmarking is
used the same way in that it measures
a plan against other plans with the same
characteristics in terms of assets, cash-
flow, number of participants, number of
non-participants, average account bal-
ance, fees (both stated and unstated),
and much more. Some benchmarking
services will compare a company with
others in the industry, so a company can
see how it compares to its competition.
This can be especially useful in an
Three Keys to a Successful 401(k) Plan
Unlock the potential for your clients and
their participants
By Steven E. Parmelee, Member, Employee Benefit Plans Special Interest Group
advocacy community education