Regardless of Philosophy, Low Cost Funds Offer an Edge

The active versus passive investment philosophy debate has been going on for decades. Certainly there are merits to both strategies, but rather than argue the pros and cons for each side let’s instead focus on how low-cost funds can be used regardless of which strategy is employed.

Too often when we look at a prospective client’s 401(k) fund menu, we see a list of expensive funds loaded with 12(b)-1 fees and other forms of revenue sharing. Or, in the case of an insurance platform group annuity product, we see expensive sub account investments with additional layers of cost. This can be indicative of several things. The plan might have an advisor who cannot work on a fee basis, and therefore must collect commissions through the use of 12(b)-1 fees. It might also mean that the plan fund menu has not been reviewed in a number of years. Either way, one thing is for sure — those high cost funds can be preventing your employees from saving enough for retirement. Studies have shown that even a .50% reduction in investment costs can add tens of thousands of dollars to your employees’ account balance over time.

Again, this is not an argument for or against an active or passive investment philosophy. It is certainly possible to design an entire menu of actively managed funds that are relatively inexpensive, and outperform the index net of fees, by using the institutional share class. Most of the time, 12(b)-1 fees and other revenue-sharing are stripped out. Unfortunately, many plan sponsors are unaware that other share classes of these funds even exist.

Not only do these higher fees have an impact on your employees’ ability to save for retirement, but when your advisor is paid through commissions instead of fees, it can impact their ability to deliver unbiased, conflict-free advice to your participants. In addition, it can hinder their ability to act in a fiduciary capacity. One of a plan fiduciary’s primary responsibilities is to understand all of the fees associated with their company’s 401(k) plan, including investment costs. It is crucial to have an independent, unbiased analysis performed on your plans’ investments so that you can ensure you are meeting your fiduciary obligations. And by lowering the cost of the plan’s investments you can provide your employees with a much better vehicle for saving for retirement.

So, regardless of whether your plan employs an active or passive investment philosophy — or a combination of both — it is crucial to make sure that the plan is using the lowest cost share class available.