7 Criteria to Evaluate Your Current 401(k) or 403(b) Plan

As more lawsuits are filed against Plan Sponsors and Plan Fiduciaries, many companies and nonprofits are taking steps to evaluate their current defined contribution plans.   Here are seven criteria we suggest should be used to evaluate your current plan.

1. Fund Suite

How many investment options do you have? Does your plan allow for Exchange Traded Funds (ETFs)?

Recent lawsuits filed against university 403(b) plans highlight the fact that many plans have hundreds of investment options. Plan participants have paralysis and can’t fairly allocate among so many overlapping options, many of which may be underperforming high cost mutual funds.

Your best option may be open architecture, whereby a fund suite of about 28-42 funds are carefully selected from over 20,000 mutual funds and exchange traded funds (ETFs)
Use of low cost ETFs may lower overall fund expenses. Too many investment options and/or your plan does not allow for ETFs – It’s a red flag!

2. Investment Policy Statement and Ongoing Monitoring

ERISA does not require an Investment Policy Statement, but does suggest that there be guidelines. So why not have an Investment Policy Statement (IPS)? The purpose of an IPS is to set forth the policies for selecting the funds in the fund suite and the policies for monitoring and replacing poor performing funds. Funds must be selected based on fund performance vs. the benchmark and vs. the peer group. Plan participant’s time horizon and risk tolerance are also key factors. Lack of an investment policy statement and lack of a monitoring policy are red flags!

3. Plan Expenses

If your overall plan expenses are greater than 1.2% of plan assets, you may be paying too much. The negative compounding effect that expenses have on one’s future retirement is very serious. Many plan Sponsors do not even know how to calculate plan expenses and many believe that the only expense paid is the annual (or quarterly) administrative charge.

When calculating total plan expenses, you need consider the following:

a. Average fund expenses;
b. Administrative expenses;
c. Hidden charges and revenue sharing; and
d. Advisory fees

You also need to know whether these fees are a percentage of plan assets or a fixed charge. Fixed costs imply that, as assets grow over time, expenses as a percentage of plan assets will decline over time. Fully variable fee structure is a red flag!

4. Services Provided

Does your advisor do anything? What services are to be provided according to the plan documents? Independent advisors could provide many useful services, including:

i. non-discretionary investment advisory services;
ii. discretionary authority of plan assets –selection and monitoring of funds, alleviating your fiduciary risk;
iii. selection, monitoring and replacement of service providers;
iv. fee and cost review comparison of existing Plan compared to other available options;
v. ongoing monitoring of investment options and plan performance;
vi. selects the funds in the fund suite, monitors and replaces funds;
vii. participant education and enrollment, which helps to maximize plan participation;
viii. development of the Plan’s investment policy statement; and
ix. development and maintenance of a fiduciary audit file.

An advisor that charges you money for limited (or no) services, is a red flag!

5. Experience and Qualifications

What makes your advisor qualified to administer the plan, provide services to the plan and act as a fiduciary to the plan?

While the number of plans and the amount of plan assets under administration are key factors to consider, there are a few other factors that are also important. Other factors to consider are licensing, legal registration, educational background and certifications.

In our opinion, an independent registered investment advisor (RIA) is preferable to a stock broker or insurance broker – licensed to sell insurance. RIAs are supervised by FINRA and the Securities and Exchange Commission. Being independent means that they are less likelyto offer proprietary products, which is a good thing.

Educational background demonstrating expertise in business, economics, and finance are important. In addition, certifications like CFA Charterholder (CFA), Certified Financial Planner (CFP) and Accredited Investment Fiduciary (AIF) demonstrate knowledge of investing and personal finance, as well as a commitment to a Fiduciary obligation to plan sponsors and plan participants.

6. Conflicts of interest

A plan that includes revenue sharing, finder’s fees and proprietary funds may pose a conflict of interest. In order to get compensated, brokers often push poor performing proprietary funds – funds owned and managed by the third party administrator or record keeper. These funds are often higher priced compared to other available alternatives.

A broker that wants to switch you from one third party administrator (i.e. MassMutual) to another (i.e. Principal) with no good reason is a red flag! The advisor could be earning a fee equal to 1% of plan assets – making it a clear conflict of interest.

A fund suite with a significant number of proprietary funds is a red flag!

7. Suitability Standard or Fiduciary Standard – To what standard is the advisor held?

A Registered Investment Advisor is held to the fiduciary standard, while most brokers are held to a lower ‘suitability standard’. Consider it a red flag if your advisor is unwilling to agree in writing to its fiduciary duties.

For a free, no obligation review of your 401k or 403b plan, please contact

Michael Edberg, CFA, CDFA™, AIF® at 301-907-9790 or medberg@pfallc.com

IMPORTANT NOTE: This blog is for informational purposes only and comments will not be posted on this site.

Attention Income Investors: Preferred Shares May Be Overvalued!

  • For yield-starved investors, preferred shares have been beneficial.
  • The problem is many have chased yield and many preferred shares are overvalued.
  • A careful look reveals there are many preferred shares trading in excess of their call price
  • Lastly, many preferred share ETFs are skewed towards REITs and Financials – understand your sector exposures

It’s been difficult to find income and yield with global interest rates being suppressed by central banks and a lack of fiscal policy stimulus from the U.S. government. It’s been a real tax on savers and investors that depend on fixed income to support their retirement. There’s nothing inherently wrong with preferred shares, but you need to look closely at the price you pay.

a. Preferred Shares Have Been a Solid Option

By keeping rates low, it was theorized, that investors would be forced into riskier assets. As a result we saw the run-up in Master Limited Partnerships – and their subsequent demise as oil and gas prices fell. We’ve also seen a run-up in preferred shares. Below is a graph showing the performance of the iShares U.S. Preferred Stock ETF (PFF) for 2016. It shows two things: (i) high volatility with a decline of 8.5% to a low of 35.89, followed by a run-up of 12.4% from the February low; and (ii) a good overall return with a year-to-date return of over 9%, both capital appreciation and dividends (current annual yield is about 5.6%).

(Source: Charles Schwab)
Jason Zweig points out in a recent Wall Street Journal article that PFF, which seeks to track the preferred stock index market, has taken in $2.2 billion in new money so far this year. This inflow of new capital is likely the reason that the price of preferred stocks has risen, which almost never happens with most of their return coming from their fixed dividends. This year, however, almost half the 9% total return of the S&P preferred index has come from rising share prices.

b. Many Have Chased Yield and Many Preferred Shares are Overvalued.

The top 10 holdings of PFF show a few things. First, nine of the top 10 holdings are financials, which represents a significant sector overweight. Next, you can see the run-up six month returns driven by a demand for yield from yield starved investors. What you don’t see is the largest single holding is actually cash standing at 3.6% of PFF’s portfolio.


Investors are unaware of the differences between preferred shares, common equity and bonds. One key difference – preferred shares are often callable. In fact, 28% of PFF’s $17.5 billion in holdings are callable by the end of 2016, according to Jason Zweig. Issuers of preferred shares have the right —not the obligation — to redeem those securities, taking them off the market in order to refinance at lower rates. The threat of rising interest rates suggests that many of these callable preferred shares will actually be called at, typically, a price of $25.

c. Many Preferred Shares are Trading in Excess of Their Call Price

For Example, GMAC Cap Pfd shares, currently trading above $25.20 are callable on September 18, 2016 at a price of $25.

Jason Zweig points to another good example. He highlights the $950 million in preferred securities from Bank of America’s Merrill Lynch Capital Trust II, whose price shot up from $25 in February to $26.50 in June, far above the $25 par value. Then, in July, the bank announced it would call the securities on August 15, 2016. Their price fell 2% in a day. This was one of PFF’s largest holding in July 2016.

d. Many Preferred Share ETFs are Skewed Towards REITs and Financials – understand your sector exposures

About 80% of preferred shares are issued by real estate investment trusts, banks and other financial companies. Investors need to understand that they are not just gaining exposure to a ‘different financial product’, but they could be unwittingly increasing their exposure to real estate investment trusts, banks and other financial companies.

IMPORTANT NOTE: This blog is for informational purposes only and comments will not be posted on this site.

[1] Article by Jason Zweig (Wall Street Journal August 12, 2016).
[2] Jason Zweig (Wall Street Journal August 12, 2016).
[3] Jason Zweig (Wall Street Journal August 12, 2016).