Investment policy statement

Scope

Companies must do their due diligence for their employees when it comes to investments.

Regulatory citations

• None

Key definitions

• None

Summary of requirements

An investment policy statement is simply a written plan to help guide the long-term investment goals for a company’s 401(k) plan. It is created to establish the guidelines for providing investment options in the plan.

Investment objective. The objective of most plans is to offer participants a sufficient range of investment choices so they can reasonably diversify their accounts. It may be tempting to offer the latest high-flyer such as a South American emerging growth fund which may be hot at the moment. However, such specialized funds, which are usually more volatile, may not be best for the participants in the long run. The plan should include mutual funds such as interest income, balanced, growth and income, international, lifestyle funds or target-date funds, and in some cases, company stock.

Some plan sponsors add a brokerage window which offers participants the ability to purchase individual stocks and bonds in addition to mutual funds. This option is more uncommon because it should only be offered to knowledgeable and financially sophisticated participants. Any investment options chosen should be maintained in compliance with all the applicable laws governing the plan, including the Employee Retirement Income Security Act of 1974 (ERISA.)

Guidelines for selecting investment options. Some general criteria that should be used to select investment options other than company stock include:

• Use an established investment firm;
• Select a fund with a track record of at least three years, preferably five years of investment history;
• Look for competitive returns on investment options;
• Look for a large asset base for each fund; and
• Choose no-load funds (those that do not charge an additional fee for buying or selling shares), or willingness to waive or reduce loads.

As a result of recent corporate scandals, many companies now hire an independent financial consultant to assist in this process, as well as to review and monitor the funds on an ongoing basis. It is always advisable to have an attorney review the policy before implementing it.

Evaluation and review. An Investment Committee (or Board of Directors, or Trustees, depending upon the composition of the plan administration) will periodically review the fund performance and see that the investment objectives are being met. This can be done quarterly or semi-annually, but annually at a minimum. A fund that consistently underperforms its peers should be added to a “watch list.” This means that the particular fund may be eliminated if improvement doesn’t occur within a specified time period. The committee may indicate the detailed measures that will be taken at the end of the “watch list” period in its policy.

Although not required, creating and following an investment policy is a good fiduciary practice. It will also show a good faith effort should the plan ever be audited.