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Investment Advice: Proceed With Caution

Where should I put my money? That is the question of the day. No matter where you turn everyone is talking about it, at work, on television, in the newspapers, and at my own dinner table. The stock markets are impacting everyone's life. I think that the safest answer, and maybe the oldest answer, is that no matter where you decide to invest, be sure to diversify, diversify, diversify. Who hasn't heard the old saying "Don't put all your eggs in one basket." And it has never been truer than today after what we have all learned from the Enron and WorldCom debacles.

Years ago, 401(k) plans were limited in the investment choices available to participants, typically a short-term investment option (a GIC fund or money market fund), an intermediate or sometimes longer duration bond fund and an equity mutual fund targeted at long-term capital appreciation. However, over the last 10 to 12 years, plan sponsors, both because of 404(c) and participants' requests, have made a concerted effort to add a full range of investment options that cover the risk spectrum, including their own company's stock. For many people, their 401(k) plan is the primary vehicle for retirement savings and they have taken on a significant responsibility for their own financial future.

Recognizing the need to educate participants, plan sponsors have enlisted the help of outside advisors to provide educational materials for participants. This business has grown and evolved tremendously. Today

there are software packages that guide us to investment decisions based upon input of specific data about our financial goals, risk tolerance, and dollars available to invest. This all seems well and good and a simple resolution to educating participants.

However, a plan sponsor must exercise caution when selecting the appropriate package. Why? First, to avoid conflicts of interest issues. Many mutual fund companies have developed investment guidance or advice products and it would be very tempting for them to steer participants into those funds managed by the same company. But you also have to exercise caution when using third party investment guidance or advice products to be sure there is no indirect financial incentive between the third party provider and the investment fund manager. Second, a plan sponsor needs to satisfy him/herself that the characteristics of the investment options offered under their plan are adequately input to the model of the product they select. Our primary concern with the second issue is that of incorrect portrayal of stable value funds in an investment guidance or advice model.

Participants find stable value funds very attractive and for good reasons, particularly under current circumstances. Stable value funds benefit from lower volatility than money market funds and offer a similar yielding investment compared to bond funds of comparable quality and duration. In the Second Quarter 2002 issue of SVIA Stable Times, Gina Mitchell, of the Stable Value Investment Association, remarks on stable value's core as an investment option, "…Stable value has had a constant presence during the investing public's love-hate relationship with equities. It has survived the investment education campaigns emphasizing the benefits of a long-term horizon in retirement investing. It has also survived during a period where participants still believe stocks will produce double-digit returns, year-in and year-out. It has even survived the mutual funds' marketing and sales blitz for direct contact with 401(k) investors." Today, participants are once again turning toward the stable value fund as a safe haven as the markets continue to move south. In fact, stable value assets in defined contribution plans increased by 15.1% during 2001, and represented 29.1% of all defined contribution assets, according to the Stable Value Investment Association, as reported in the May 28, 2002 issue of DC Plan Investing. Given the continuing turmoil in the equity markets so far this year, we anticipate that these figures will increase for 2002.

While we truly believe in a diversified asset allocation, we do not want to see errors in investment guidance or advice models result in recommendations that participants make inappropriate changes in their use of stable value funds. Our main concern with investment guidance and advice models is how the model is characterizing the stable value fund in relation to other short-term investment options and what assumptions have been loaded into the models. If the actual historic returns have been used or a reasonably appropriate index such as the "G5 Ryan 5-year GIC master," then the conclusions that are reached may well be appropriate. However, we found that the asset allocation model offered by the service provider for our own FCM 401(k) Plan had categorized the FCM stable value fund as a money market fund and was using money market fund return history as a proxy for the returns of the FCM stable value fund. Consequently, the asset allocation model was recommending that any assets invested in stable value be transferred into the bond fund. Not only would such assumptions lead participants to make bad decisions for themselves personally, but in the worst case, decisions that could result in law suits. Even though the asset allocation models are advocating strategic asset allocation decisions, with interest rates currently at historical lows (other than on September 11th, the 5-year Treasury was last at this level in the mid '60s), any participant who acts on such a recommendation now and moves assets out of stable value and into bonds would almost certainly experience unnecessary significant capital losses when interest rates rise. Unlike bond funds, stable value funds offer principal preservation and attractive returns along with low volatility of returns. Unfortunately, with the markets as unsettled as they are, plan participants are likely to act on any recommendation that appears to have credibility.

To avoid possible future law suits for the results, Plan Sponsors must satisfy themselves that all investment options offered under their 401(k) plans, including stable value, are accurately represented in any investment guidance or advice modeling product that is offered to participants.