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How 401(k) Advisors Score Mutual Funds

How 401(k) Advisors Score Mutual Funds

| May 07, 2024

Fostering trust, accountability and financial confidence for plan participants


In the realm of retirement planning, mutual funds stand as fundamental investment vehicles within 401(k) plans, offering participants access to diversified portfolios and professional fund management. However, the process of evaluating and selecting mutual funds can be complex, requiring employers to rely on the expertise of 401(k) financial professionals.

Central to this evaluation process is the scoring formula used by advisors to assess mutual funds. Understanding this formula is paramount for employers seeking to optimize their 401(k) investment lineup and enhance participant outcomes.

The Significance of Mutual Fund Scoring

Mutual fund scoring serves as a systematic method for evaluating the performance, risk, and suitability of investment options within a 401(k) plan. By assigning scores to mutual funds based on predefined criteria, financial professionals can facilitate informed decision-making and guide employers in constructing well-diversified investment menus that work toward aligning with participant needs and preferences.

Key Components of Mutual Fund Scoring

The formula used by 401(k) financial professionals to score mutual funds typically incorporates various quantitative and qualitative factors, including:

Historical Performance: Past performance serves as a critical determinant of a mutual fund's scoring, reflecting its ability to generate returns relative to its benchmark and peer group over different time horizons.

Financial professionals may analyze risk-adjusted returns, volatility metrics, and consistency of performance to assess fund quality.

Risk Profile: Evaluating the risk characteristics of mutual funds is essential for understanding their potential downside and volatility. Financial professionals consider factors such as standard deviation, beta, and downside deviation to gauge a fund's risk profile and suitability within the context of participant risk tolerance and investment objectives.

Expense Ratios: The cost of investing in mutual funds, as reflected by expense ratios, plays a significant role in scoring. Lower expense ratios are generally preferred, as they minimize the impact of fees on investment returns and enhance long-term wealth accumulation for participants.

Manager Tenure and Strategy: Assessing the tenure and investment strategy of fund managers provides insights into their experience, expertise, and alignment with long-term investment goals. Financial professionals may evaluate manager tenure, turnover ratios, investment philosophy, and adherence to stated objectives when scoring mutual funds.

Fund Characteristics: Consideration of fund characteristics, such as asset allocation, sector exposure, and style consistency, enables financial professionals to assess the diversification and alignment of mutual funds with overall portfolio objectives and participant preferences.

Empowering Employers Through Transparency

Transparent communication between employers and 401(k) financial professionals regarding the mutual fund scoring formula is essential for fostering trust, collaboration, and informed decision-making. Employers should actively engage with financial professionals to understand the methodology, weighting criteria, and assumptions underlying the scoring process.

By gaining insight into the mutual fund scoring formula, employers can:

  • Enhance Investment Due Diligence: Understanding the factors driving mutual fund scores enables employers to conduct thorough due diligence and assess the suitability of investment options within their 401(k) plans.
  • Optimize Investment Lineups: Armed with knowledge of mutual fund scoring criteria, employers can collaborate with financial professionals to optimize investment lineups, identify high-quality funds, and diversify investment offerings to meet participant needs.
  • Promote Participant Education: Transparent disclosure of mutual fund scoring methodology empowers employers to educate plan participants about the selection process, investment objectives, and risk considerations associated with available investment options.

Prudent Retirement Plan Management

The importance of employers understanding the formula used by their 401(k) financial professional to score mutual funds cannot be overstated. By demystifying the scoring process, employers can make informed decisions, optimize investment lineups, and empower participants to pursue their retirement goals.

Transparent communication and collaboration between employers and financial professionals lay the foundation for prudent retirement plan management, fostering trust, accountability, and long-term financial confidence for plan participants.


Important Disclosures:

This material was created for educational and informational purposes only and is not intended as ERISA or investment advice. If you are seeking investment advice specific to your needs, such advice services must be obtained on your own separate from this educational material.

Investing in mutual funds involves risk, including possible loss of principal. 

This article was prepared by FMeX.

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