Many people use plan-level rates of return to determine the quality of an investment lineup. However, several variables may impact plan-level rates of return making them not as useful as a plan management tool. They may actually be counterproductive when trying to determine the quality of an investment lineup. As an extreme example, you may have a lineup full of excellent mutual funds, but if your participants have 50 percent of their plan assets in a cash account, the plan’s effective rate of return would suggest a poor investment lineup. Furthermore, a reasonably well-funded plan with an appropriately conservative fund menu would have an average rate of return appear sub-par during a bull market.
There are many other examples, most of which revolve around participant behavior (poor diversification, market timing, etc.) effecting a composite rate of return for the plan. We all recognize that participants consistently may not make responsible investment decisions, but imprudent participant investing should not color the quality of the investment menu.
This makes any conclusions based on average plan-level rates of return potentially misleading and probably counterproductive. A better idea is to focus on the investments that are designed to reflect the plan’s goals, objectives and participant demographic needs...like a well-selected target date fund (TDF). The TDF return rates, over a reasonable time period, make more sense for comparative purposes. These options are already optimized in terms of asset allocation and divisible by age group to obtain a more risk-based conclusion. Lastly, many experts project that the vast majority (more than 80 percent) of defined contribution assets will be in TDFs by 2020, which makes this evaluation even more meaningful.
For more information on how to best determine the quality of your plan’s investment lineup, contact the advisors at MFA Asset Management today.
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