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The Small Business 401(k) Plan in 2014: Our Clients Redefine the Conventional Wisdom - Part 1 of 3

Greg Carpenter

December 29, 2022


Smaller 401(k) plans pay more in fees and have a harder time implementing best practices – right? Not our clients.

I got to thinking how Employee Fiduciary’s clients compare to the “typical” small business 401(k) plan. My hypothesis was that our clients are getting it right – but I wanted to see the data. We’ve been in business for 10 years and serve over 2,000 clients with close to $2 billion in assets – a decent sample size. We also have the data in real time on our systems, eliminating any polling error or extrapolation from public documents. We looked at our clients’ use of index investments and other low cost investments, target date funds, ETFs and the “leakage” from loans and hardships. We also developed trend lines for the years 2011, 2012 and 2013.

I believe that what we found sets a new standard for what smaller plans can achieve in today’s marketplace. The first takeaway: The use of low-cost index investments is not only increasing, it is accelerating. The percentage of assets in index investments has increased in each of the last three years. A greater proportion of new plans are choosing index investments now than ever before.

We looked at plans that chose investment line-ups in 2011 or earlier, in 2012 and in 2013. The percentage of total plan assets invested in indexed investments for 12/31/xx of each years:

Index Funds Percentage

Findings were consistent for both larger and smaller plans - percentages were remarkably similar for across all plans. We also found no differentiation for the sponsor’s industry – this trend holds for brick and mortar businesses, tech and professional firms.

The significance of the trend to index investments

Risk aversion - Business owners now equate greater fees with greater risk to their core investments. The higher the fee paid, the larger the hurdle to overcome to achieve (or beat) market results. To some degree, business owners are beginning to equate higher fees with a willingness by some investment managers to court high-risk high-reward investments. Investors are skeptical of taking on more risk.

Asset allocation strategies are embraced – Plan participants understand that an appropriate asset allocation is key to achieving investment goals. To meet long-term investment goals investors understand they need broad exposure to stocks. While I believe that some of the change is due to better investor education, I think most of the embrace of asset class exposure comes from the near zero return on money market funds and interest bearing accounts concurrent with the “Great Recession.” People are 100% sold on stocks, but interest rates are too low to justify investment.

The “nest egg” concept – 401(k) participants who have joined the work force since the general demise of defined benefit plans (everyone under say, age 55) realize that the 401(k) is probably their #1 financial asset. Home equity used to be the top asset for most families, but who is relying on home equity for retirement after the real estate bust. Stated another way, the idea of a nest egg makes a growing number of investors planning for retirement down right ornery and protective regarding how they invest their retirement savings. We see that in many of our frugal plan sponsors – they want what they want because they perceive the stakes to be high – and rising.

If these trends continue, the market for small business 401(k) plans may look very different in the future. Investments appear to be moving toward commoditization, and limited ability for providers to add value using traditional pricing strategies will be pressured. The so-called entry level plan may be a modest index arrangement. As plans grow in asset value, they may then (and only then) seek out greater returns by pursuing more aggressive attempts to outperform the market. In effect, rationalizing risk factors that reflect new investment technology.

My next blogs will cover our findings on how our clients use “set it and forget it” and the leakage of assets from plans.

Stay on the frugal cutting edge!

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