by: Roxanne Fleszar
from: The Boston Business Journal
Aug. 14, 1998

Benefit programs and, specifically, well designed 401(k) plans have become a diffententiating characteristic for attracting valuable and needed employees, but many 401(k) plans have flaws that can put the company at the recruitment disadvantage to the astute job candidate. For other employees, the flaws may not be noticeable to plan participants until a downturn in the market.

Terrific annualized investment returns for several years have given Plan Sponsors and employees a false sense of security. Many have not measured their performance against appropriate benchmarks nor looked at the volatility of their funds to know what to anticipate when the stock market moves to its norm of about 10% annualized return. 401(k) plan sponsors need to make certain their 401(k) plans are competitive in up and down markets and that their employees understand risk and volatility. Plan sponsors must take responsibility for making certain that their employees' hard-earned money works as hard for them as they did for it.

Many companies have moved from a defined benefit plan to a defined contribution plan, such as a profit sharing and/or 401(k) plan. Unfortunately, they have not implemented the same oversight mechanisms they had with defined benefit plans, nor implemented the education programs necessary for employees to become responsible for their own secure retirements. Neglecting to compare investments against appropriate benchmarks and failing to offer ongoing education designed to enhance investment knowledge are two major hindrances to an effective 401(k) plan.

Companies frequently have no idea how their specific fund options fare against like funds (i.e. a balanced fund against the Morningstar balance index). Such flaws can irreparably affect the accumulation of assets for retirement.

For example -- the following illustrates the difference a 1% additional return can make on a $10,000 investment over the course of 10 and 30 years: *
                                            10 Years       30 Years
Balanced Fund A (earning 8%)    $21,589.25    $100,626.57
Balanced Fund B (earning 9%)     $23,673.64    $132,676.78

The participant invested in Stock Fund B would realize an additional $2,084.39 in his account over ten years, and an amazing $32,050.21 gain over thirty years!

*This assumption is based on a $10,000 initial investment, with no additional deposits made to the account, and annualized rates of return of 8% and 9% respectively.

Companies can formulate a winning 401(k) plan that will not only assist employees in reaching their retirement goals, but also help to protect the company against future liability. The most important steps to adopt an Investment Policy Statement (IPS). The IPS is a blueprint that takes into account all the procedures a company should undertake to protect its employees' investments.

By law, employers must make available to prospective participants a Summary Plan Description (SPD), which outlines the specific provisions of the plans, such as eligibility requirements, vesting schedule, and matching. Plan sponsors may also wish to make available the IPS to assure employees that appropriate safeguards exist to protect their assets from both administrative and market risk.

Overall, the IPS outlines both basic and specific information regarding plan design, criteria for investment selection, and the involved parties' fiduciary responsibilities. A well-written and valuable Investment Policy Statement will include the following:

• Plan Objectives and Goals. The IPS should clearly state the Plan's objectives, as decided on by the Plan Trustee(s), and communicated to the Plan's Investment Advisor. Additionally, it should set forth tools for measuring the Plan's progress toward these goals.
• Investment Selection Criteria. This section of the IPS will outline the variable used for investment selection, as well as the basis for assessing results and recommending changes to the portfolio. Furthermore, it should detail methods of performance evaluation. Specifics to look for include the utilization of benchmark comparisons and investment time horizons in comparison to risk levels.
• Duties & Responsibilities. This segment of the IPS documents the duties and responsibilities of the Trustee(s), Custodian, and the Investment Advisor.
• Asset Allocation. For Plans utilizing asset allocation funds, documentation should show how assets are divided among the various asset classes for each fund, as well as the amount acceptable variance in each sector. Details should also be provided as to how often and under what circumstances a fund is rebalanced.

Once an Investment Policy Statement has been adopted, it can serve as a guideline for the Plan Sponsor's future investment-related decisions, thus improving the Plan's ability to attain retirement plan goals for its participants. Furthermore, establishement of an IPS can significantly increase a Plan's capacity for ERISA compliance.