At Cable Hill Partners, we believe that sponsors of 401(k) plans should work to reduce liability in four primary areas of fiduciary responsibility.

• Management of Plan Operations
• Investment Selection, Monitoring and Removal
• Service Provider Selection, Monitoring and Removal
• Participant Communication and Engagement

Today’s topic will be in the Investment Selection, Monitoring and Removal area – specifically, the importance of diversifying plan investments to minimize the risk of large losses – a primary duty of all fiduciaries.

In today’s investment landscape, investors can become enamored with “shiny objects” that promise to gain an edge. Sector funds, precious metal funds, and cryptocurrencies are easy examples of asset-classes/investments that are known to be highly volatile. With the high concentration of technology stocks in today’s market environment, it may not be easy to identify the risk of volatility, even in mainstream investments like S&P 500 index funds or asset-allocation portfolios.

Keep in mind that large losses require even larger gains to achieve long-term portfolio growth.

EXAMPLE: your portfolio or investment loses 50%

• A 50% loss on $1,000,000 drops the value to $500,000
• A 50% gain on the $500,000, would only get back to $750,000
• The portfolio would need a 100% gain to get back to $1,000,000

Minimizing the risk of these large losses is a fundamental duty of plan fiduciaries under the Employee Retirement Income Security Act (ERISA) and can have a substantial impact on the plan and its participants:

1. Long-Term Savings: 401(k) plans are typically designed for long-term retirement savings. Large losses can significantly diminish the accumulated savings over time, potentially jeopardizing retirement goals.
2. Impact on Compound Growth: Compound interest and growth are fundamental to 401(k) plans. Large losses can interrupt or reverse this growth, making it harder to recover lost funds and achieve retirement targets.
3. Limited Contribution Limits: There are annual limits to how much a participant can contribute to a 401(k), so losses can't always be offset by increased contributions. Protecting existing funds can be critical for long-term wealth accumulation.
4. Emotional Impact: Large losses can lead to emotional decisions such as selling investments at a low point, which locks in losses and undermines the potential for recovery when the market rebounds.

Diversifying investments can help minimize the risk of large losses within the 401(k) portfolio by helping spread risk across different asset classes and reduces the impact of downturns in any single investment.

Ultimately, the goal of a 401(k) plan is to provide financial security in retirement. Minimizing large losses helps ensure that the savings accumulated over the years are there when participants need them.

We hope this gives you a better understanding of why diversifying plan assets is so important for setting participants up for success, as well as why it is a key part of the fiduciary duties laid out by ERISA.

Let’s chat if you have concerns about your current investment offerings in your 401(k) plan.