Fiduciary Duties in an Employer 401(k) Plan: Choosing Between Passive and Active Investments

Mandated by the Employee Retirement Income Security Act of 1974 (ERISA), the selection and monitoring of retirement plan investments demands careful attention and decision-making. The ‘where’ of investments isn’t the only focus of plan managers; active versus passive investment fund management is another consideration in an employer 401(k) plan. In this article, Meghan Hannon, CRPS®, Senior Retirement Plan Manager, explains the key differences between active and passive investments in 401(k) plans.

ERISA outlines the necessity of a diverse investment lineup within plans, emphasizing the significance of thoughtful investment choices. The driving force behind compliance with ERISA, the intent to set retirement plan participants on a path to success, compels careful consideration of whether to include passively managed funds, actively managed funds, or a blend of both within the investment lineup. Understanding the differences between passive and active fund management guides plan sponsors to make informed decisions for their participants.

Passive Fund Management

Passive funds, also known as index funds, mirror the composition of benchmark indices like the S&P 500 or NASDAQ Composite. These funds track and replicate the index’s movements rather than making active decisions on stock and bond selection. Their appeal lies in lower management fees and the ability to align with broader market momentum, catering to investors seeking long-term market exposure. Passive fund management also simplifies retirement plan investments, where matching the larger trends can be more cost-effective than attempting to predict future performance. However, passive funds aren’t immune to risks associated with market downturns or individual index components faltering.

Active Fund Management

On the other hand, actively managed funds require plan managers to make dynamic decisions based on their strategy, market conditions and performance expectations. They aim to surpass benchmark returns, employing various approaches like quantitative or fundamental analysis. While they offer the potential for added value, their management fees tend to be higher due to increased research demands and associated investment risks. Expected future performance is also important in active fund management and adds valuable data to guide decision-making for companies that issue individual stocks and bonds.

Deciding Between the Two

Deciding between passive and active fund investments requires a thoughtful approach. While risk preferences can influence this decision, the primary focus of an employer 401(k) plan is a diversified investment range, including stocks, bonds, short-term options and asset allocations.

Comparing track records, historical performance, and fund manager tenure is crucial in evaluating both passive and active investments. These factors not only fulfill fiduciary obligations but also serve as primary metrics for investors when making informed choices.

Target-date funds and managed accounts, classic components of various retirement plans, offer a layer of additional active investment management. Examining these two portfolio models for the blend of passive and active investments can provide additional insights for your unique employer 401(k) plan.

Helping You Get There…

Ultimately, the debate between passive and active investments might not be a debate at all. Passive funds offer cost-effective exposure to market sectors, while active funds provide strategic growth opportunities. Both strategies harbor uncertainties, but the goal for any plan participant lies in achieving a risk-adjusted return that secures financial readiness for retirement.

Tailoring your plan’s investment choices to participants’ needs and preferences, backed by well-documented reasoning, is crucial to fulfilling ERISA duties. Providing robust education and guidance further enhances participants’ chances of successful investment outcomes. Contact us today to learn how the Boulay Financial Advisors, LLC team supports you in managing your employer 401(k) plan investments.