In the wake of the market meltdown and the current credit crisis, 401(k) plan participants are agonizing over the dramatic decline in the value of their portfolios. Investment options previously considered safe — fixed-income and cash equivalents — have proven to be highly volatile.
And, while investors in their 20s and 30s may have time to make up even a 30% loss, a boomer retiree can suffer permanent financial damage with a 10% loss. The underlying fact is that all variable investment options, even fixed-income and cash-based options, carry market risk, and always have.
Plan sponsors typically have been very concerned about lawsuits pertaining to suitability of equity investment options in their retirement plans and less concerned about the cash and fixed-income options and the holdings within those options. Consider the participant who invests in a small-cap-growth investment option. The expectation is that there is substantial risk with this investment.
If the risk has been properly disclosed and it trails the benchmark by a few points it might raise a few eyebrows but, because the risk was well-defined, the volatility is considered par for the course.
Now consider the participant who is more risk-averse and invests in a fixed income or cash investment that becomes extremely volatile due to market conditions and experiences a 10% to 15% drop in value.
Compare the fiduciary risk each of these investments presents to the sponsor and think about which one has the potential to create more liability.
If you asked plan sponsors five years ago about the bond investments within their plans, they may have shrugged their shoulders, perhaps not knowing how to answer the question, but not concerned about it, either. It has been a given that bonds are less risky than stocks. However, in today's environment, that conventional wisdom is out the window and many sponsors are unaware of the gap in their investment due diligence.
They have focused intently on benchmarking the equity funds versus their peers and indexes, with little concern about the potential volatility of fixed and cash options. In this environment, fiduciaries need to focus at least as much effort on fixed-income and cash investment options as they do on the equity options in their retirement plans.
Plan sponsors can mitigate this risk by taking an active look at the overall makeup of their fixed-income and cash portfolios. Here are some steps to take:
• Ask your vendors and managers for their views on the market and their investment strategies for weathering the storm.
• Add additional fixed and cash accounts that allow your plan participants to fully diversify. If necessary, add options whose holdings are materially different to ensure that participants have a well-diversified safe harbor to help weather financial storms.
• Monitor your fixed-income investment options closely, applying the same logic to monitoring these options as you do with your equity strategies.
While risk in equity funds is more transparent than ever in retirement plans, fixed-income and cash accounts may be the next big wave of fiduciary exposure for plan sponsors. They need to be aware of all risks and strategies they can use to reduce their exposure, then take steps to offer diversity and reduce risk.
Keith Soranno is a regional sales executive with Securian Retirement Distributors of St. Paul, Minn.