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Guest Editorial Making Risk Tolerance Questionnaires Mandatory for 401k PlansBy 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. The Answer - The Same Way At least this should be the answer. As sponsors of investment plans such as a 401k and fiduciaries for these plans we have an obligation to provide our participants with the right kind of investments they need in order to meet their own investment goals. This is not just about what the sponsor feels is adequate or necessary - it is about what your participants require based on their ability to take risk and build themselves efficient investment portfolios. Your investment choices or options in your 401k plan should reflect the risk tolerance of your participants. If you have a group of older and more conservative employees you should give them more conservative options. If they are demographically younger and more aggressive, you should provide them with more risky and aggressive investments. The investment options should not be just whatever you think is a good mix - it should be tailored to meet the investment and financial planning needs of your participants. You, as their sponsor, are providing a very important investment program which is supposed to help them fund their eventual retirement. You need to know what their risk tolerance is just as much as any other investment professional before recommending an investment. How Do You Know? The question then becomes - how do you know the risk tolerance of your participants? You know by giving each participant in your 401k plan a risk tolerance questionnaire and helping them understand and complete it. It is not enough to put it on a website or in a newsletter and hope that it happens. Help them understand the questions so they can fill it out. The main benefit of assisting an employee in filling out an investment risk tolerance questionnaire is to make them aware of their personal risk tolerance. Although we would like to be able to teach our participants all about stocks, bonds and mutual funds it is more important to help them to understand the most basic of investment questions; are they conservative, moderate or aggressive investors? Without this knowledge, they cannot make good investment decisions with their 401k plan money. Once the risk tolerance questionnaire is completed by the participants it should compiled and analyzed in the aggregate to help the sponsor understand the demographics of their participants and their overall sensitivity to risk. Just as with an individual investor, once you have an understanding of their risk tolerance then, and only then, should you move on to the selection of investment options for your 401k plan. The Wrong Way I have seen company owners and their advisors put together 401k plan options purely on the whim of what the owner or manager believes would be adequate. It would be impossible that any owner or manager could even know if the investment options they selected were prudent if they had never seen completed risk tolerance questionnaires from their participants. They're simply shooting in the dark. That is not fair for their participants and it is certainly not a best practice for sponsoring 401k plans. Another mistake would be to allow the mutual fund company or your pension plan consultant to recommend options without getting risk tolerance questionnaires from each participant and analyzing them. How do they know what the best options are without taking this fundamental step? How do you recommend investment options for several hundred (or thousand) employees without knowing something about their sensitivity to risk or average time horizon before retirement? Mandatory Risk Tolerance Questionnaires Just as in the investment world where it is required to have some understanding of an investor's risk tolerance before recommending any investments, the same ethical standard should apply to 401k plans and their participants. It should be mandatory that each 401k plan participant have in their file a completed and signed risk tolerance questionnaire. This is for your protection as well as the participants. By having these documents in your participant's file you can prove that you have taken the most basic and elementary step in educating your employee about their retirement plan investments. More important than fiduciary liability, however, is the fact that you would be providing an excellent service for the employee to help them understand their risk-taking ability and how to make better decisions. With Roth 401k plans coming and more of our employee's money going into retirement accounts at work, we need to view these plans as one of the employee's main savings and investment vehicles during their working career because that is exactly what they are becoming. Ready or not, we are in the investment and retirement planning business and we need to start treating 401k plan participants as the individual and distinct investors they are. Other articles by Russ McAlmond: Putting Participants First, The Current State of Ethics in the Financial Services Industry, Financial Education for Your 401k Plan and Inefficiencies of Investments in the 401k World. ### 401khelpcenter.com is not affiliated with the author of this article nor responsible for its content. The opinions expressed here are those of the author and do not necessarily reflect the positions of 401khelpcenter.com. This article is for informational and educational purposes only and doesn't constitute legal, tax or investment advise. | ||||
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