Fund Choices in a 401(k) Plan, Do's and Don'ts

Myth: Choice is Good inside a 401(k) Plan

Americans love freedom and choice! So isn't it good to have many fund choices in 401(k) plans? To answer that question, we have to address diversification.

Diversification: The Employee Retirement Income Security Act (ERISA), the Uniform Prudent Investor Act (UPIA) and the Restatement 3rd of Trusts (Prudent Investor Rule) all agree that the key to long term investment success is broad diversification of risk.

Therefore as a plan overseer, one of your most important duties is to increase the probability that each participant has maximum diversification in their account. If you want to know more about why diversification is so critical, please contact us.

Too many funds choices is bad because it takes away from diversification. What's "too many"? See common mistakes, next section below.

Common Mistakes

1) Tyranny of Choice: If your plan participants invest in more than one fund in the same asset class - they unknowingly concentrate their assets, causing less diversification, more volatility which hurts their long term returns. This problem occurs most often in the large cap space. Here's a great article on this problem, "The Tyranny of Choice."

2) Bundled Plans: Often a bundled plan of funds - one fund family - will share their "best investment ideas" among the funds. So you will find the same stock in many different funds and participants' assets become concentrated in certain individual stocks. Again, this lowers diversification, increases volatility and hurts long term returns.

3) Retail mutual funds: Often retail mutual funds have the problem of style drift or not investing as their fund name would suggest. This leads to, yes, you guessed it, less diversification, higher volatility, lower returns.

What to Do Next

Easiest Solution: You're probably not trained as an investment advisor. Use an ERISA Section 3(21) independent advisor that insists on bringing an ERISA Section 3(38) independent advisor with them. The 3(38) advisor takes over responsibility for fund selection and monitoring. They do it for you, relieve you of significant fiduciary liability and are cost competitive. They are investment experts - and specifically for 401(k) plans which are uniquely different than an investment advisor investing your personal account..

If you are delaying a move to a 3(38)-based plan, then you just need to avoid the most common mistakes listed above. Break the myth, be a "choice contrarian" and help your participants get better long term returns through greater diversification and lower volatility!

Most plans ought to be able to achieve good diversification and avoid concentration with about 10-15 funds. A few of your participants may rebel a bit at first, but you can confidently move forward knowing that you are doing what's best for everyone in th plan and fulfilling your fiduciary oversight responsibility with flying colors!

We can provide a free benchmark of your plan which you are supposed to be doing anyway, contact us for more information or click on the Schedule a Meeting button below.

Fiducaries vs. Financial Product Salesperson (8/10/2010)

Follow the Money It's important to know how your advisor gets compensated because it impacts their behavior: so follow the money!Two ways for a financial advisor to get paid:1) Commissions from the products they sell you, or from security trades they make for you or2) A percentage fee charged on the assets under management  - called "fee-only advisor".The problem with commissions is they influence advisor loyalty toward their boss or to the products they sell, rather than to you.   It's not an indictment of the person receiving the commissions.  Their intentions are probably good, but all things being equal why deal with the possibility that their judgment could be impacted?  Often hidden fees and penalties are present in this environment as well as we point out in an example below.The only investment professionals held to a fiduciary level of responsibility are Registered Investment Advisors (RIA) often called fee-only advisors.Lynn O'Shaughnessy wrote a wonderful article, "Financial advice better from fiduciary than broker" on this important topic. Common Mistakes 1) Using a commission-based advisor (broker) and not demanding (in a nice way)complete disclosure of all fees.    Be specific and get it in writing.2) Comparing expenses of a fiduciary RIA vs. a broker before getting a complete disclosure of the broker's fees.    You may mistakenly assume the RIA is more expensive since they fully disclose.   Usually RIA's are competitive, and often provide superior service for the same or less cost.(We know of a recent situation where an RIA was charging an initial one-time financial planning fee of $2,000 with ongoing planning at no cost.   The prospective client decided to hire a broker with "no up front fee".  However, when the client asked further disclosure questions at our advice, an up front hidden fee of more than $20,000 was revealed.   At that point $2,000 sounds pretty good and the client received a comprehensive initial strategy for it.)3) Using multiple advisors as a fail-safe or diversification strategy.   Unfortunately this puts you in charge of allocating assets between the advisors which is likely not your area of expertise   It's best to have one trusted advisor with access to excellent diversification vehicles allocate all your investable assets.  You overall level of diversification will be higher. What to Do Next Thinking about trying a new advisor?   We encourage you to work with a fiduciary RIA fee-only advisor since their fee structure is aligned with your interests.    No matter who you work with, demand fee transparency - disclosure in writing.Begin with The End in Mind:  For any successful journey, you need a compelling vision AS THE OVERALL FIRST STEP.We help people put their vision on paper using a tool called Financial Road Map for Living Your life on Purpose.    We facilitate Road Maps for individuals/couple as a community service, even knowing in advance that you may not be a fit to us. Contact us to schedule a Road Map meeting.  We can also provide a 20-30 minute Road Map demo on the phone.You may wish to read articles about how to choose an advisor.   Be sure tounderstand their fees.    Call us.   We have a book we can share with you that includes advice on how to find a good advisor, what to ask, how to interview.Newsletter Archive

Until our next issue... Sincerely, John O'ReillyO'Reilly Wealth Advisors

Investing 101: Discipline & Diversification (7/13/2010)

New, Practical & Brief NewsletterOne of these newsletters could save you from making a big mistake. This is basic and "ready to act on" advice for those serious about making smart choices.By Luck or On Purpose?We want to help you grow your wealth. To prove that, we are willing to show you how to implement these ideas on your own.If you can invest with discipline and diversification over long periods of time, your returns will be higher than most everyone else. Your success will be purposeful; the few that exceed your results were lucky. Luck or on purpose? Your choice!Discipline: 1) Stay in the market, 2) stick to your strategy long term and 3) manage other aspects of your finances so that your portfolio can grow undisturbed.Diversification: Own a little bit of everything using low expense ratio funds. To accomplish this we use Dimensional Fund Advisors (DFA) which is available only to select advisors. The next best approach is using Vanguard index funds as your portfolio building blocks. We are willing to share our Vanguard portfolio designs, contact us.Discipline and diversification are fundamentally sound and can be found in lofty documents like the Uniform Prudent Investor Act (UPIA) and Restatement 3rd of Trusts (Prudent Investor Rule). There are many great articles on these concepts, click here for one of our favorites.These complex concepts have been presented briefly. Not convinced; need more explanation? We would happy to help, just contact us.Common MistakesTypically mistakes can be traced to, you guessed it, poor discipline and diversification.1) Poor Discipline. Moving in and out of "hot" mutual funds. Continually switching advisors. Timing the market. Abandoning your long term strategy at a whim. Often these behaviors can be described as "chasing performance".2) Poor Diversification: Individual stocks. Retail mutual funds with less than 500 holdings that overlap each other. Multiple advisors. All of the aforementioned hurt diversification which means greater volatility and lower long term returns.3) The Allure of Active Investing: Active investing (to be covered more in a future newsletter) seems to make sense - I can "work hard, analyze and study my way to market-beating returns". However active investing lacks substantial diversification and/or relies on market-timing - common mistakes #1 and #2 above.What to Do NextOur culture and media would have you believe that investing is 90% of personal financial success. Actually, it is 10%. The devil is in the details. If you do the other 90% poorly, the good investing work could be blown up.Next steps on investing: we offered above to show you how to implement a diversified strategy on your own. Contact us whether to seek our help, or to learn how to do it yourself w/Vanguard.Begin with The End in Mind: For any successful journey, you need a compelling vision as THE FIRST STEP OVERALL.We help people put their vision on paper using a tool called Financial Road Map for Living Your life on Purpose. We facilitate Road Maps for individuals/couple as a community service, even knowing in advance that you may not be a fit to us. Contact us to schedule a Road Map meeting. We can also provide a 20-30 minute Road Map demo on the phone.You may wish to read articles about how to choose an advisor. Be sure to understand their fees. Call us. We have a book we can share with you that includes advice on how to find a good advisor, what to ask, how to interview.Newsletter ArchiveUntil our next issue.Sincerely,John O'ReillyO'Reilly Wealth AdvisorsSave 25%Times are tough. For those of you joining us in our top two tiers of service that include free ongoing financial plan updates, get 25% off the cost of your initial financial plan.

O'Reilly Wealth Advisors Inaugural Prudent 401(k) Fiduciary Newsletter

O'Reilly Wealth AdvisorsInaugural Prudent 401(k) Fiduciary NewsletterGreetings!Welcome to our inaugural issue!In these newsletters, we will expose the myths about 401(k) Plans.Does your 401(k) Plan have an ERISA Section 3(38) fiduciary?In our first article, you'll learn more about Plan Sponsors delegating investment decisions to an ERISA 3(38) fiduciary advisor. You might want to click on the article, "Prudent Fiduciary Part 1", to the right, and come back to this introduction once you've read the first article.What are the ERISA 3(38)-advised plan benefits?Complete fee transparencyFar less fiduciary liability on plan overseersMuch higher quality investment vehiclesAdvisor-managed portfoliosBuilt-in checks and balances due to the independence of the team members.No mutual fund 12b-1 fee-sharing (and the resulting conflicts-of-interest & lack of transparency)The most significant improvements available to be made to 401(k) plans cannot be made without moving to an ERISA Section 3(38)-advised plan. At the end of this introduction we reveal how to find out if you have a 3(38)-advised plan. (It is highly unlikely.)Why are there so few 3(38)-advised plans? Because mainstream providers are making plenty of money without having to take on the increased fiduciary responsibility.Bundled 401(k) plans that dominate the 401(k) market have fewer and in some cases NO checks and balances.In our 3(38)-advised plans - O'Reilly Wealth Advisors is an independent 3(21) fiduciary, Advisors Access is an independent 3(38) fiduciary, McCready & Keene is an independent TPA/record-keeper that will not accept 12b-1 revenue streams and TD Ameritrade is an independent custodian with strict fiduciary requirements. Checks & balances are built into our plans.To get started, call us for a no-obligation 401(k) health check-up conducted by independent 3(21) and 3(38) registered investment advisor fiduciaries. Valued at thousands of dollars and takes just a few weeks from start to finish. To take advantage, just e-mail or give us a call, john@oreillywa.com or 760-804-0910.Next issue's introduction will include a few examples of how the mainstream 401(k) providers often mislead by using the word "fiduciary" extensively while not actually taking on any fiduciary liability.Does your plan have an ERISA Section 3(38) fiduciary? Please make sure your request is specific and includes a deadline; "Please give us a signed letter, on your letterhead stating that you take on ERISA Section 3(38) fiduciary liability." The answer is unlikely to be "yes" - but if it is and you get the letter confirming -- we want to be the first to congratulate you! Good job!Prudent Fiduciary Part IScott Pritchard | Managing Director, Advisors AccessA look at the major issues that are shaping fiduciary best practices today.First, let me say that I am not an attorney. So, as I wade into interpretation of ERISA, I gratefully acknowledge my reliance on the previous work and wise counsel of numerous ERISA attorneys who have been kind enough to share their opinions with me.With that disclosure, I will attempt to shed light in a two-part series on an issue that is receiving an increasing amount of attention in the 401(k) marketplace: The roles of ERISA section 3(21) fiduciary investment advisors and section 3(38) fiduciary investment managers.The growing awareness of these roles seems to be driven by two key factors:Numerous 401(k) lawsuits over the past few years have made plan sponsors increasingly aware of their fiduciary responsibility and liability, which they are now keenly interested in limiting.The investment industry is aware of this growing concern and is seeking to capitalize on the "fiduciary" business opportunity.While ERISA has always defined the various roles of fiduciaries to retirement plans, most industry practitioners have simply not been aware of the finer points and how those can benefit plan sponsors and participants. Now, however, as more plan sponsors seek out the services of fiduciaries, Wall Street is increasingly marketing itself as such, especially under the "co-fiduciary" label. So it is imperative that plan sponsors, and those that advise plan sponsors, understand the key differences between the various fiduciary roles.There are a variety of functional fiduciaries in the operation of a qualified retirement plan, including the plan administrator, trustee(s) and members of the investment/benefits committee. Our focus here, however, will be on clarifying the roles of "Investment Advisor" and "Investment Manager."In a white paper commissioned by SageView Advisory Group, attorneys Fred Reish and Joe Faucher of the Reish & Reicher law firm explained the 3(21) Investment Advisor and 3(38) Investment Manager roles this way:Where committee members lack the needed technical knowledge to properly select the investments, they are required to hire knowledgeable advisers. In ERISA, those investment advisers are sometimes referred to as section 3(21) fiduciary investment advisers. However, while the use of knowledgeable advisers is evidence of a prudent process (particularly if the adviser is independent), the committee continues to be the primary investment fiduciary. As a result, it remains the primary "target" for plaintiffs' attorneys and the U.S. Department of Labor (DOL).Where committee members desire additional protection, they should consider appointing a discretionary investment manager to select and monitor the investments. In ERISA, those discretionary managers are referred to as 3(38) fiduciaries. Appointing an investment manager insulates the fiduciaries against losses (or inadequate gains) arising out of claims that the investments were not appropriate or prudent. Fiduciaries who appoint an investment manager to control the selection and monitoring of the plan's investments are responsible only for the prudent selection and monitoring of the investment manager which, for attentive fiduciaries, is a manageable task.The essence of the difference between these two designations is that a 3(21) advisor makes recommendations and a 3(38) manager makes decisions.So, if a plan sponsor wants to retain the responsibility for investment selection and monitoring, hiring a 3(21) investment advisor can be part of a prudent fiduciary process. But if a plan sponsor wants to be insulated from the responsibility and liability for investment selection and monitoring, then a 3(38) investment manager should be engaged.Most groups holding themselves out as "investment advisors" in the 401(k) industry are operating as 3(21) advisors (if, indeed, they are acting as fiduciaries at all.) The 3(38) manager designation requires a greater level of fiduciary responsibility, and only a minority of firms are willing to accept the increased liability that comes with the 3(38) designation.In Part II, I will provide guidance on how to identify what type of fiduciary you may be working with now.Edit ImagePhantom FiduciariesBy W. Scott SimonClick on the link to find another article on the same topic. W. Scott Simon is a prolific writer on this topic.http://www.morningstaradvisor.com/articles/article.asp?docId=4432(if necessary, past this link to your browser)In This IssuePrudent Fiduciary Part 1Phantom FiduciariesJoin Our Mailing ListJohn O'ReillyO'Reilly Wealth Advisors

Fresh Start

As the cute AT&T commercials with the children conclude, "it's not complicated; more is better."  Click here to see one of the fun AT&T commercials.  Below I have presented yet another well written fact-based article on passive investing often referred to as "indexing". However, articles on passive investing fail to capture the difference between indexing and passive investing as done by O'Reilly Wealth Advisors utilizing DFA Funds. They lump them together and call them indexing.  But there is a difference.  What is an index? Example, S&P 500 is 500 large US Companies published by Standard and Poor's.  There are thousands of indexes.   They are arbitrary - folks gather in a conference room and choose a bunch of companies they think are representative of an asset class. Sure they may use some tools to help them choose, but ultimately it is a list that is limited in length. Indexing works because you get reasonably good exposure to an asset class by "buying the index".  But why not get excellent exposure to an asset class instead of just reasonably good?  It's not complicated, more diversification is better!  DFA scientifically develops their list, and their goal is to choose almost ALL the companies in an asset class for a complete exposure. DFA's passive funds provide a more thorough exposure than index funds. It can be argued that DFA is a more appropriate "index" representing an asset class because it is more complete exposure to that asset class. More diversification wins.  And sure enough, in most asset classes, in most periods of time, DFA funds beat index funds. Sometime these differences are small and sometime significant. We have extensive data of the performance of a DFA-based portfolio vs. an index fund based portfolio.  I also have data on how individual DFA funds perform vs. their benchmark index. If you would like to see this data, please let us know. Here's yet more proof of the success of passive investing in general.   Our readers have been bombarded with proof in our newsletters - but we won't stop providing it!------------------------------------------------------ Index Funds Gain Momentum: A 2-part Research Article on "Passive" funds in Forbes Magazine  Rick Ferri, a regular writer on passive investing (often called "indexing") recently posted a 2-part article in Forbes.  We provide the links here as well as the executive summaries. Also read a brief explanation on how "indexing" is different from passive investing utilized by the funds (DFA) our firm employs. Index Funds Gain Momentum (Part 1) - Click Here. Index Funds Gain Momentum (Part 2) - Click Here. Part 1 Executive Summary A brief history on mutual fund passive investing is provided. Specific numbers demonstrating the growth in passive investing is presented. Part 2 Executive Summary The benefits of index fund investing is provided. Specific data on results, how and why is presented. What to Do Next The crucial first step is to understand what is most important to you and establish goals in alignment.  Then choose someone that can bring a team of independent experts together and assemble the advice (prioritized in your best interests) to make it happen. That said, it is completely appropriate to choose investing as the first topic. We regularly analyze folk's current investment strategy with nothing expected in return.   (We'll analyze other aspects of your strategy if you wish.) We look at: Overall Performance (vs. benchmarks & our model portfolios) Portfolio Design Diversification Fees & Expenses Give us a call.    760-804-0910

Until next issue. Sincerely, John O'ReillyO'Reilly Wealth Advisors