The Fund Selection Process

Plan design and the day-to-day operations are important factors in a healthy retirement plan but participation and investment performance form the backbone of any plan and will have the greatest impact on employee's retirement asset gathering quest. 

Expecting to have mutiple investments that are all in the top performing class year after year isn’t a likely outcome.  That doesn't mean it is necessary to settle for a mundane line-up of index funds or ETF's either (we are capable of offering either or both). It has been our experience that plans that offer investments with a demonstrated history of providing consistent results through all market environments are likely to have happier and wealthier participants.

Finding the best performing investments from the past is a simple task. Finding investments that are likely to perform well over the next five or ten years is another proposition entirely.

History is all we have to work with yet we know that the next five years will be different than the past five years. Whether the next five years will prove to be better, worse or similar, we do not know.

Selecting managers that performed well during one period doesn’t guarantee success either as that success could well have been dependant on a particular economic or market climate.

So how do we go about finding our recommended funds? What goes into the screening process? What qualities of a fund receive higher consideration than others?

The most successful investment managers we know tend to make investments based on criteria that is universally relevant in most any economic environment. Managers that view each investment they make as if they were going to buy the whole company; this is the same type of criteria investors like Warren Buffet employ when analyzing a company for purchase.

These managers ask questions like: How much cash does this company generate each year? Who is the competition and are they likely to take market share away from our company? How much am I paying for this company—is it worth it? Do I think I can make at least 10% annualized return on investment over the next 5 years if I buy this company?

This type of thinking is largely responsible for the success of our investment recommendations to date. Importantly, we were able to recognize the quality of these funds five, ten and fifteen years ago so when we report that a given fund has performed in the top 10% within it’s category over the past five and ten years, our client's participants actually benefited from that performance.

Clearly, we cannot promise similar results going forward and some of our chosen investments haven’t performed as well. Our goal is to provide investment options that consistently perform in the top 30% within their category (large growth, large value, etc.), this as measured over multiple rolling five year periods. To us the worst acceptable result is mediocrity—average performance. Those that cannot meet the standard are replaced, which is one advantage of open architecture plans; individual pieces of the plan can be changed without changing the entire plan structure.

Fees and investment: There are those that focus on the fact that most actively managed mutual funds fail to outperform the market index with any regularity. This is true. Somewhere in the area of 80% to 85% of funds fail to outperform “the market” on a consistent basis. If we accept this as fact then the argument goes that we should just invest in the index. Fees are the only thing that we can actually have some control over so we will invest in low cost funds that are index funds.

Our approach is not anti-low-fee in any way. But if 85% of funds fail to outperform the market consistently doesn’t that leave 15% that do outperform consistently? If we can find investments that have an extended track record demonstrating the ability to outperform and the consistency that provides confidence that this history will continue going forward doesn’t it make sense to choose that investment?

Funds that meet this criteria might not have the lowest fee but most have reasonable fees. One such fund has outperformed the S&P 500, net of fees, in every ten year period since it’s inception (1969) and did so by roughly 2% per year on average. That kind of consistency has given our clients the opportunity to truly make the most of their retirement plan investments. 2% may not seem like a lot but over a long enough time period the extra 2% can mean twice as much income at retirement.

Do you think your plan might benefit from this type of investment thinking?

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