Inefficiencies of Investments in the 401k World

By Russ McAlmond, President of Evergreen Capital Management Inc. Evergreen provides investment consulting services to 401k plans and high net worth individuals around the country. He can be reached at 503.223.8880 or at russ@evergreencap.com.

Many years after employers got out of the business of making investment decisions for their employees by virtually eliminating defined benefit plans they are still not giving their employees the options and information they need to build efficient investment portfolios. By not fulfilling their obligations to take this responsibility seriously, they are keeping their employees from building more efficient and less risky portfolios and damaging the ability of millions of Americans to retire comfortably.

A Classic (but not unusual) Example

I sat down the other day with a Fortune 500 company retirement plan participant to help with her 401k investment allocation. Her plan provided 13 (12 equity and 1 fixed) investment choices that ranged from very good to very poor. Some options were actively managed and others were passive or targeted retirement vehicles, which were conveniently managed by the company providing the 401k plan and whose performance was mediocre. The last option was her employer's stock that was highly touted by the company as an excellent investment option (didn't they learned anything from Enron?).

As a professional financial advisor, I find it very difficult to work with the poor choices that employers provide their employees in one of the most important retirement savings accounts they have. It seems the companies select 401k providers based on how easy they make plan administration instead of spending enough time on the quality and kind of investment options they select for the plan. How can any company say they are providing efficient investment choice for their retirement plan participants when they offer such a poor selection of investment options?

Further, other than their home, the employees 401k plan is the largest pool of money they have and often makes up a sizeable part of their net worth. As a result, the choice of investment options they have available has a lot to do with whether the employee retires with sufficient assets.

Too Many Choices?

Yes, I am aware of the argument that too many choices will 'confuse' the unsophisticated participants. This is an unsupportable and hypocritical position for a company to take. First, the company takes the position that it considers you sophisticated enough manage the investments in your 401k plan. Then it takes the position that you are not sophisticated enough to make too many choices so it will put a limit on those so as not to confuse you. The only thing the company is actually doing is preventing the employee from being able to build a truly efficient portfolio with their own tax-deferred money.

Looking at this in another way may make the picture even clearer. Take just a few billion dollars of the trillions of dollars that individuals have in retirement plans and give it to the company to manage it. Do you think the company would be satisfied with only 12 investment choices? Of course not. As fiduciaries they would demand access to the investment universe of thousands of different investments and rightly so. This is not the option that most 401k plan participants have.

Minimal Investment Options for 401k Plans

Companies should provide their 401k plan participants, at a minimum, the following 401k plan options. This is not the most, it is the least. Anything less is not giving your participants the variety of investments they need to construct a basic investment portfolio. Preferably, companies will provide even more investment options for their participants.

The following table is my suggested list of options that should be made available in every 401k plan.

Asset Classes
US Large Cap	Value	US Bonds	Medium
US Large Cap	Blend or Index	US Bonds	Short
US Large Cap	Growth	International	Value
US Mid Cap	Value	International	Blend or Index
US Mid Cap	Blend or Index	International	Growth
US Mid Cap	Growth	Emerging Markets	Value
US Small Cap	Value	Emerging Markets	Blend or Index
US Small Cap	Blend or Index	Emerging Markets	Growth
US Small Cap	Growth	REIT
US Bonds	Long	Stable Asset
Plus:
	Conservative Managed Portfolio
	Moderate Managed Portfolio
	Aggressive Managed Portfolio

This is a total of 23 (you will have 24 with company stock) different investment options including three managed portfolios for those employees that have no desire to try to manage their own money. In addition, the investment options selected for these minimal asset classes and managed portfolios should be selected by a knowledgeable investment advisor (or knowledgeable company employee) and be continuously monitored and replaced if either ethical violations take place, managers retire, managers are replaced, or any other sign that the investment performance of the manager may not continue into the future.

We need to give our 401k plan participants, at the very least, the minimal ability to build efficient portfolios for this critically important asset that they are accumulating for their future. After all, we have created the environment that made them responsible for these decisions, now let's give them the most efficient tools to work with.

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