Do your investment reviews have damaging biases? When it comes to investment reviews, would you rather have an independent one or a conflicted one? Assuming you answered independent one, is that what you are getting? Many investment professionals have some kind of bias. If that bias is based on a conflict of interest between increasing their compensation and lowering the returns of your participants that puts you in danger if discovered.

A 1% higher fee is associated with a 28% reduction in plan balance over 40 years. 1 Said another way would you prefer a million-dollar balance or $720,000 balance? Sometimes a bias of belief system is a cover for a bias based on another reason. Further, some investments paid different or higher fees than another so it’s in the interest for your participants to be educated on the prudence of certain asset classes at that would reduce the compensation of your plans

Broker bias and investment reviews

Commonly investment professionals working on retirement plans are referred to as Plan Advisor or financial advisor. However investment advisor representatives are paid by a fee and it must legally work in the interest of participants. Brokers are compensated from investments that pay a cost that is bundled into the investment that they sell. For example, you save $50,000 into a 401k profit sharing plan and they may receive .50 basis points or $2500.  This compensation comes out of your balance. Let’s say that another investment would only pay those 25 basis points or $1250 less. It is in their interest to show you the merits of the one that pays them $1250 more.

Would they be biased in explaining why the more expensive one is better than the other? The less expensive fund might be one of those lower cost, so-called index-like investments. They may be biased in offering you funds that try to beat the market. These funds typically use some kind of investment manager that hopes to use market timing and/or stock picking methodology to beat the market.

Quite possibly when you grow weary of the bad results from the higher cost investment, the broker substitutes another fund payinf a higher commission based on recently good performance. If that is being done to you, you likely would not realize that the alternatives presented to you were based on anything other than the returns of the substituted fund.

Most registered representatives are not experts in act what the Employee Retirement Income Security Act expects for a fiduciary investment process. While they may be a good stock picker that is not what the law requires of you.

Recordkeeper bias and investment reviews

The recordkeeper, the firm that offers the funds and keeps the records of all the participants may also be biased. First, many firms use a phrase called open architecture. I don’t know about you but when I hear open, I think that means open as-in unobstructed. When some recordkeepers say open they mean less limited than their alternative. Some also charge you more for the privilege of their less limited platform. This is sometimes done because they have a revenue sharing arrangement with some of the investment companies. This is how that works, you invest in a mutual fund and they pass along money to the recordkeeper. Depending on your viewpoint, this can be seen as paying for shelf space or that they are passing along costs for functions that the recordkeeper is handling for them on your behalf.

Let’s say that the revenue sharing is 25 basis points which they get to keep. Wouldn’t they rather have $625 more of your money rather than less? Do you assume that someone at the recordkeeper has somehow blessed these investments as good? They may have ulterior motives.

Bundled providers and Investment reviews

Typically in areas where we have no specific industry expertise we often put our trust in a well-known brand name. Because we don’t know what questions to ask, we look to them to help us with questions and answers. You may have selected a 401(k) service provider where the broker, investments, recordkeeping and third-party administration are all provided by a firm with the same brand name. This is sometimes referred to as direct or directly sold. However when all parties have the same company affiliation there is an increased risk of a conflict of interest. You may refer to this in your business as increasing share of wallet. If this is increasing their share of wallet today and not increasing your participants retirement paychecks in the future you are at risk from a failed Department of Labor audit or class-action lawsuit.

Do your investment reviews monitor risk

Many fiduciaries have told me that they either rely on the Morningstar rating system or the Lipper rating system to help them evaluate investments. However, they could not explain Morningstar’s philosophy versus Lipper’s philosophy or methodology with respect to those determinations. Morningstar ratings are based not on future expectations but on past performance.

Morningstar published an article that said the fees charged to or loaded onto investments are a better predictor of future realized investment returns. The Department of Labor concurred and made it mandatory that all of the providers receiving more than a $1000 of compensation from your plan disclose their fees. Do you include fee reviews as part of your investment reviews?

Validating an independent reviewer

I recommend working with an investment advisor representative that is also accredited investment fiduciary who has taken the time to learn about standards and the specific issues surrounding the evolving requirements for a prudent process intended to help participants retire. That person or entity should also be willing to formally sign on as an investment fiduciary on your plan acting as either an investment advisor or designated investment manager [ERISA 3(21) or ERISA 3(38)]. These types of financial professionals will also use some type of tools designed to provide independent investment reviews. I would ask them for copies of their contracts and have an attorney with expertise in this area review the contract to make sure you understand what you and your participants are getting.

• GAO, PRIVATE PENSIONS, Changes Needed to Provide 401(k) Plan Participants and the Department of Labor Better Information on Fees, 2006
• This information was developed as a general guide to educate plan sponsors, but is not intended as authoritative guidance or tax or legal advice. Each plan has unique requirements, and you should consult your attorney or tax advisor for guidance on your specific situation. In no way does advisor assure that, by using the information provided, plan sponsor will be in compliance with ERISA regulations.