Understand the Actions That Can Enhance or Undermine 401(k)smedia01.commpartners.com/NIPA/2016/Session14/1S_v2Understan… · 1 Understand the Actions That Can Enhance or Undermine

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Understand the Actions That Can Enhance or Undermine 401(k)s

Tom Warren, National Speaker

American Funds

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Tom Warren, National Speaker American Funds

In challenging audiences to look at things differently, American

Funds Senior Vice President Tom Warren draws on extensive

experience as well as his diverse educational and professional

background. The result is an insightful and refreshingly practical

perspective on the retirement plan world.

Tom’s roots in the retirement plan industry run deep, having

joined American Funds in 1993 as an original member of its

workplace retirement group. His programs are steeped in real-

world experience, complete with stories and analogies aimed at

helping his audience get results. Above all, he maintains a

passion for helping working Americans prepare for their biggest

financial challenge, retirement.

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Tom Warren, National Speaker American Funds

After earning his bachelor’s degree in microbiology from the

University of Oklahoma, Tom worked for two years at the Mayo

Clinic as a clinical microbiologist before joining his family’s oil

and gas exploration business, where he helped originate

institutional joint ventures. From there, Tom went on to Smith

Barney’s Asset Consulting and Evaluation group, which helped

pioneer the use of separately managed accounts.

Tom lives in Sarasota, Florida, with his wife and enjoys boating,

alpine skiing and four-wheeling.

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© 2014 American Funds Distributors, Inc.

Investments are not

FDIC-insured, nor are

they deposits of or

guaranteed by a bank

or any other entity, so

they may lose value.

Figures shown are past

results and are not

predictive of future results.

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© American Funds Distributors, Inc.

Consider the Growth of Retirement Plans

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Social

Security

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ERISA

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401(k)

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Retirement

Reform

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© 2013 American Funds Distributors, Inc. AI-00000 -A V1

Building a Better 401(k)

Understand the Actions That Can Enhance or Undermine 401(k)s

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Good Intention

Offering a Large Selection of Funds

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What’s the ideal number of funds

to offer in a retirement plan?

Pop Quiz

A. 3

B. 24

C. 50

D. 600

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Fund #3

34%

Fund #2

33%

Fund #1

33%


Three Options Can Spark Interesting Investor Behavior

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2

10

18

24

1978 2001 2011 2014


Sources: MarketWatch.com, BrightScope.

# of Fund Options Available

Over the Years, the Number of Options Has Grown

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Psychology Teaches Us About Investor Behavior


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Aisle 2 24 Varieties

60% Visits

3% Purchased

30% Purchased

Aisle 1 6 Varieties

40% Visits

Photo: beautythatmoves

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Can There Be Too Much of a Good Thing?


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Boxes show where you are invested


Source: U.S. Social Security Association via ssa.gov

Swedish Social Security System

600 + Funds

Investment

Option Overload

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Employees May:

Potential Unintended Consequences

• Freeze up from option overload

• Limit how much they contribute

• Decide not to participate in the plan at all

• Chase performance

• Realize poor diversification due to asset overlap

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For the Best Possible Outcomes:

Prescription

• Offer diversified options vs. a diversity of options

• Avoid meaningless duplication

• Simplify participant decisions

• Consider a target date fund as the plan’s qualified

default investment alternative

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Good Intention

Using Style Boxes to Select an Investment Menu

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How many Morningstar

style boxes are there?

A. 9

B. 18

C. 27

D. 48

Pop Quiz

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Value Blend Growth

Large

Mid

Small

Boxes Show Where You are Invested

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Style-Pure Funds Are More Desirable. Or Are They?


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Several Academic

Studies Suggest Otherwise


*Howard/Callahan study, “The Problematic ‘Style’ Grid,” found that constant unconstrained investing is superior to constrained style-pure investing with improved

performance as much as a 339 basis points.

Basis Points*

339

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When Using the Morningstar Style Grid to Develop a Plan Menu,

Understand That:


• Convenience may come at a price

• There is still work that needs to be done

• Participants may miss out on good investments

• What fits the grid may not be appropriate

for a plan’s participants

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To Avoid the Pitfalls of Style-Box Investing:

Prescription

• Understand the proper use and limitations

of the Morningstar style boxes

• Build plan menus based on participant goals

• Think outside the box

• Remember that less can be more

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Good Intention

Seeking to Reduce Liability with a Fiduciary Warranty

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What is generally covered

by a fiduciary warranty?

A. Investment selection/monitoring

B. Fee-related issues

C. Fiduciary conflicts of interest

D. Violation of the plan document

Pop Quiz

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Does a Fiduciary Warranty Relieve Me of My Fiduciary

Responsibility?

What Many Plan Sponsors Really Want to Know Is This:


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Source: 2014 Bloomberg BNA report, as reported by NAPA Net and Pension & Benefits Daily.

Bloomberg to Retirement Plan Sponsors:

“ Buyer beware. Experts say that many warranties offered by providers are

little more than a gimmick.

Bloomberg BNA Report ”

Caveat Emptor: A Word of Caution

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Be Aware That a Fiduciary Warranty Could:


• Instill a false sense of security

• Create costs that outweigh the benefits

• Trigger new fiduciary responsibilities

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In Order to Reduce Fiduciary Liability:

Prescription

• Be sure to read the fine print

• Implement a fiduciary review process

• Consider fiduciary liability insurance

• Consider third-party assistance

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Good Intention

Offer a Loan Option to Participants

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Which of these reasons does not

qualify a participant for a 401(k) loan?

A. Paying off debt

B. Emergency expenditure

C. Home purchase

D. Paying bills during unemployment

E. Education costs

F. Special event (wedding/vacation)

Pop Quiz

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29% have taken a loan

from their plan


Source: 2014 TIAA-CREF survey Borrowing Against Your Future

43% have taken two

or more loans

44% say they regret the

decision to borrow

More and More Participants

Are Using Their Retirement Accounts

Like Checking Accounts

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There Are Upsides and Downsides to 401(k) Loans

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• The plan may feel more

attractive to employees

• Higher retirement plan

participation rates

• Higher retirement plan

contribution rates

• Inexpensive borrowing

alternative

• Potential negative impact on

retirement savings

• Money is no longer protected

from creditors

• Plan administration becomes

more complex

• Danger of default if

participant is terminated

Upside Downside

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Source: BenefitsPro.com, 2014

Retirement Plan Leakage Is a Concern

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Source: BenefitsPro.com, 2014

Generating More Than

$1 Billion in Federal Income

Tax Revenue Per Year

$6 billion

Pension Research Council Estimates

Annual Defaults on 401(k) Loans

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Retirement Plan Loans Can:


• Result in lost momentum for plan participants

• Mean that participants are taxed twice

• Create more work for the plan sponsor

• Affect the cost of the plan for all concerned

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To Make the Best of a Participant Loan Option:

Prescription

• Educate participants about loans

• Reduce the allowable number of loans

• Limit loans to participant deferrals

• Consider repayment options

• Increase the loan origination fee

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Good Intention

Frequent Fund Replacement for a “Best-in-Class” Menu


Photo: naokoeats.com

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How long does the average

investor hold a mutual fund?

A. 10 years

B. 6 years

C. 3 years

D. 2 years

Pop Quiz

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Market declining

Bottom Prices low

Top Prices high

Market rising


Emotion Drives Most Investors To Be Their Own Worst Enemy.

Why Did Investor Returns Lag the S&P 500 by 4.32%?

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1

3

4

5

6 7

8

9

10

11

12

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Large-cap core

Mid-cap core

Small-cap core

International core

Intermediate bonds

Across all categories

Category

83

13

33

51

60

502

Number of 10-year top-quartile funds

81%

92%

76%

88%

85%

90%

Funds below the median for a 3-year period

61%

69%

41%

49%

60%

63%

Funds below the median for a 5-year period

Top-Quartile Funds Have Lagged Over Shorter Periods.

Source: The Next Chapter in the Active Versus Passive Debate (2012 update), an analysis of active management performance, persistency and efficacy.

DiMeo Schneider & Associates, LLC.

Many Funds Experience Periods of Disappointment

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Source: The Journal of Finance, “The Selection and Termination of Investment Management Firms by Plan Sponsors” by Goyal and Wahal, 2008

Participants May Pay the Price.

2.03%

11.55%

BEFORE change

Based on three-year

cumulative excess returns

(above the benchmark),

sponsors decided to drop

under-performing

investments (black bar)

and added over-performing

investments (blue bar).

Dropped investments

Added

investments


When Plan Sponsors Chase Returns …

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Based on three-year

cumulative excess returns

(above the benchmark),

sponsors decided to drop

under-performing


and added over-performing

investments (blue bar).

3.23%



Participants May Pay the Price.

After being removed

from the plan, dropped


outpaced newly added

investments (blue bar) by

1.03% over three years

Dropped investments

Added

investments


2.03%

11.55%

BEFORE change AFTER change

4.26%

When Plan Sponsors Chase Returns …

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Plan Sponsors Should Take Caution:


• There is a natural bias toward action

• Chasing returns can produce disappointing results

• Short-term sensitivity can be detrimental

to long-term outcomes

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For Better Potential Outcomes:

Prescription

• Concentrate on the long term by using

an Investment Policy Statement

• Consider quantitative and qualitative criteria

• Use a watch list

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Better Outcomes.


Good Intentions.

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Investors should carefully consider

investment objectives, risks, charges and

expenses. This and other important

information is contained in the fund

prospectuses and summary prospectuses,

which can be obtained from

a financial professional and should be read

carefully before investing.

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© 2014 American Funds Distributors, Inc. AI-00000 -A V1

Multiple Perspectives.

One Approach.®

RPGEPO-057-0914 / 9638s44805

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Understand the Actions That Can Enhance or Undermine 401(k)smedia01.commpartners.com/NIPA/2016/Session14/1S_v2Understan… · 1 Understand the Actions That Can Enhance or Undermine