Focus on process in 401(k) investment policy statement

Question My financial adviser to the 401(k) plan for my medical practice suggested we draft an investment policy statement for the plan. Is that necessary, since my employees are responsible for selecting their own allocation among the investment options?

Answer: The short answer to this question is "yes."

An investment policy statement (IPS) is an important document that serves three critical roles within your 401(k) plan. First, it helps provide a paper trail in the event of a Dept. of Labor audit or potential litigation from employee participants. Second, it helps keep decision-makers focused on the long-term goals and objectives of the plan. And third, it sets forth criteria to be used for monitoring the investment options within the plan.

Although fiduciaries/trustees are not responsible for the individual investment choices made by the employee participant, they are responsible for selecting and monitoring the investment options in the 401(k) plan.

As the trustee of the plan, you can be held personally liable for a breach in fiduciary duty as it relates to the 401(k) plan. A properly drafted IPS can mitigate some of the potential litigation exposure if it sets forth reasonable and clear roles and expectations for participants, beneficiaries and fiduciaries.

Another important component of an IPS is to keep fiduciaries focused on the long term when short-term volatility in the markets might be distracting them.

Finally, an IPS can provide the framework to help determine the criteria for which investment options will be monitored. It is important that periodic -- ideally, quarterly -- reviews of the investment options within the plan be conducted.

Some criteria for potential inclusion within the investment option lineup include but may not be limited to: performance relative to benchmarks/peer groups; performance relative to assumed risk; manager track record/tenure; assets under management; expense ratio/fees; and stability of the manager/organization.

Further, once an investment option is selected, it is critical that the IPS outline criteria for ongoing monitoring, such as placing a fund on a "watch list" or removing a fund from the investment options.

Sample watch list criteria could include performance below the median for its peer group over three or five years, change in the professionals managing the portfolio or evidence that a manager is deviating from its stated style or investment strategy.

The ultimate decision to remove an investment option cannot be determined by quantitative factors alone. Therefore, assistance from your financial adviser can be valuable in this process.

As you draft the IPS, keep in mind that the focus should be on the process rather than investment performance. According to the "Prudent Investment Practices" handbook from the Foundation for Fiduciary Studies, which provides training and research exclusively on investment fiduciary responsibility and portfolio management: "Fiduciaries' liability is not determined by investment performance but rather on whether prudent investment practices were followed. It's not whether you win or lose, it's how you play the game."