RPA 2 - Module 1-13

The efficient market hypothesis has three cumulative forms. Define each of these. (Retirement Plan Investing Essentials, pp. 149-151

(1) The weak form of efficiency states that above-average profits should not be expected by studying past stock prices and volume data. (2) The semistrong form of efficiency is concerned with all publicly available information. (3) The strong form states that stock prices reflect all information, public and nonpublic. This form goes beyond the semistrong form in considering the value of information contained in announcements.

A stock was purchased for $30 per share. A dividend of $2 per share was received by the investor. What is the return relative if the stock is sold for (a) $34 or (b) $25? (Retirement Plan Investing Essentials, p. 42—Example 2-4)

(a) $2 + $4= $6, and $6 divided by $30 is 20%. Therefore, the return relative is 1.20. (b) $2 + (-$5)= -3, and -3 divided by $30 is -10%. Therefore, the return relative is 0.90.

What are (a) the size effect and (b) the January effect anomalies? (Retirement Plan Investing Essentials, p. 159)

(a) The size effect is the observed tendency for smaller firms to have higher positive abnormal stock returns than large firms. (b) The January effect is the observed tendency for small company stock returns to be higher in January than in other months.

The total return for an investment over a period of time was 24.65%. During the same time, the inflation rate was 4.33%. What was the inflation-adjusted return? (Retirement Plan Investing Essentials, p. 49—Example 2-11)

1.2465/1.0433 = 1.1948, and 1.1948 minus 1 = .1948 or 19.48%.

What is a 12b-1 fee? (Retirement Plan Investing Essentials, p. 18)

A 12b-1 fee is a "distribution fee" that covers a mutual fund's cost of distribution, marketing and advertising. The fee ranges as high as 1%.

With a buy-and-hold strategy, does an investor have to perform any functions after the stocks are selected? (Retirement Plan Investing Essentials, p. 127)

A buy-and-hold strategy means an investor buys stocks and holds them until some future time in order to meet some objective. The emphasis is on avoiding transaction costs, taxable transactions, additional search costs, the time commitment to portfolio management and so forth. Even with a buy-and-hold strategy, an investor has to perform certain functions such as dealing with dividends (whether to reinvest them in other securities) and adjusting the portfolio for risk considerations.

What is an investment company? (Retirement Plan Investing Essentials, p. 3)

An investment company is a company that is engaged primarily in the business of investing in and managing a portfolio of securities. By pooling the funds of thousands of investors, a selected portfolio of financial assets can be purchased with a specific purpose, and the investment company can offer its owners a variety of services in addition to diversification, including professional management and liquidity.

What is data mining? (Retirement Plan Investing Essentials, p. 162)

Data mining refers to the search for patterns in security returns by examining various techniques applied to a set of data. In most cases, the patterns do not stand up to independent scrutiny or application to a different set of data or time period.

Describe the difference between diversifiable and nondiversifiable risk. (Retirement Plan Investing Essentials, p. 114)

Diversifiable risk, or nonsystematic risk, is a unique risk related to a particular security (company) and can be eliminated (though not completely) through a well-diversified portfolio. Nondiversifiable risk, or systematic risk, is the variability in a security's total returns that is directly associated with overall movements in the general market or economy and cannot be avoided regardless of how well a portfolio is diversified. Virtually all securities have some systematic risk, whether bonds or stocks, because systematic risk directly encompasses interest rate risk, recession, inflation and so on.

What are key considerations in evaluating and adopting TDFs? (Reading B, Evaluating and implementing target-date portfolios, Study Guide Module 7, p. 24)

Four key considerations in evaluating and adopting TDFs are: (1) Asset allocation glide path (2) Passive or active management (3) Packaged or customized solution (4) Impact on participant portfolios.

Explain why abnormal returns are not possible if the market is perfectly efficient. (Retirement Plan Investing Essentials, p. 149)

In a perfectly efficient market, stock prices always reflect immediately all available information. Every security's price is equal to its intrinsic value. This means investors cannot use new information to earn abnormal returns because available information is already impounded in stock prices.

When choosing a lifecycle fund provider, what should plan sponsors and investors evaluate? (Reading A, An Overview of Lifecycle Funds, Study Guide Module 7, p. 19)

In choosing a lifecycle fund provider, plan sponsors and investors should evaluate the investment methodology employed in constructing the funds.

Do investors draw faulty conclusions when it comes to understanding the risk that inevitably accompanies an investment decision? (Retirement Plans, p. 194)

Investors underestimate the risk of certain investments. Such inappropriate risk discounting occurs when investors have familiarity with an investment. This is particularly true with company stock held in retirement plans. Although company stock fails to be a diversified investment and is even more risky since it is correlated with one's source of income, individuals have repeatedly concentrated their 401(k) holdings in company stock. This is risky since the individual may lose his or her job if the company experiences financial difficulties and simultaneously may see the value of his or her retirement plan plummet.

What are market anomalies, and why is their study important when considering market efficiency? (Retirement Plan Investing Essentials, p. 156)

Market anomalies are in contrast to what would be expected in a totally efficient market and constitute exceptions to market efficiency. Therefore, their study is important when considering market efficiency to determine how pervasive such anomalies are and whether they are exceptions or whether the market under study is less efficient than believed.

Assume that a portfolio consists of only two securities, X and Y, and that 50% of the portfolio is invested in each. The standard deviation of X is 35%, and the standard deviation of Y is 25%. Using equation 3-12 on page 84 of the text, what is the portfolio risk if the correlation coefficient is (a) +1, (b) -1, (c) 0 or (d) +0.55? (Retirement Plan Investing Essentials, pp. 84-86)

Module 3, LO-2.5

Do peers appear to have some degree of influence when it comes to planning for retirement? (Retirement Plans, p. 193)

Peers seem to have an effect on whether individuals choose to participate in retirement plan offerings. A study suggested the potency of peer influences by noting the high rates of participation in a retirement program within certain work groups at an employer. Peer effects would seem at odds with the view that saving and investing decisions are made by economic agents using a rational process.

Explain the concept of dominance. (Retirement Plan Investing Essentials, pp. 98-99)

Portfolios on the efficient frontier (efficient set) dominate other portfolios because they offer the best return-risk combinations available to investors. Portfolios with inferior return-risk relationships are "dominated."

How has PPA encouraged plan sponsors to provide investment advice to plan participants, and what responsibilities does a plan sponsor have related to the selection of an investment advice provider? (Retirement Plans, p. 517)

Since passage of PPA, retirement plans' fiduciaries can provide investment advice to participants and be paid an additional fee for providing this advice. Before PPA, providing investment advice for an additional advisory fee by a plan fiduciary would result in a prohibited transaction under ERISA and IRC. Now that PPA allows plan sponsors to offer investment advice services, it is important to note the fiduciary responsibilities that apply to these services. Plan sponsors are not required to offer investment advice services. However, if plan sponsors offer such services to their participants, there are certain fiduciary responsibilities. Plan sponsors must prudently select the advice provider. Subsequently, the plan sponsor also must monitor the investment advice provider.

Does the SML hold constant over time? (Retirement Plan Investing Essentials, p. 177)

The SML shows the required return and risk at a particular point in time. The SML can, and does, change over time as a result of (1) changes in the risk-free rate and (2) changes in the risk premium, which reflects investor beliefs.

The Value Line Investment Survey, which is the largest and perhaps the best known investment advisory service in the country, has had a very strong performance in its rankings. Why couldn't an investor realize excess returns by following its rankings? (Retirement Plan Investing Essentials, pp. 161-162)

The Value Line Investment Survey rankings and changes in the rankings do contain useful information. However, there is evidence that the market adjusts quickly to this information (one or two trading days following the Friday release) and that true transaction costs can negate much of the price changes that occur as a result of adjustments to this information.

Suppose the risk-free rate is 5%, the expected rate of return on the market portfolio is 20% and the beta coefficient is 1.2. Using the CAPM, what is the required rate of return on the asset? (Retirement Plan Investing Essentials, pp. 175-177)

The required rate of return is: 0.05 + 1.2(0.20 - 0.05)= 23%.

What is the P/E ratio anomaly? (Retirement Plan Investing Essentials, p. 158)

There is some evidence that securities with low P/E ratios have provided positive excess returns.

How many securities are enough to diversify properly? (Retirement Plan Investing Essentials, pp. 115-116)

Traditionally, as few as 20 stocks were believed to be adequate. Recent studies have indicated that 50-60 stocks appear to be needed to ensure adequate diversification. As the number of stocks increases, the probability of under-performing the market decreases.

Explain the retirement plan features that allow individuals to manage retirement assets using a wealth management approach. (Retirement Plans, p. 565)

Various aspects of retirement plan design allow individuals to manage retirement assets using a wealth management approach. Today's individual participant is, in most cases, more empowered to strategically manage his or her retirement assets. This trend has been supported by both marketplace forces and governmental policy initiatives. An individual should make the most of this empowerment. This is true both during the accumulation phase and during the distribution phase. Because individuals have the ability to select investments and, in some plans, determine whether their contributions occur on a pre- or after-tax basis, individuals can control both asset allocation and tax status of their accumulating retirement resources. An individual also can determine what type of retirement savings vehicle to use to accumulate assets.

How does wealth management retirement planning link asset accumulation with distribution planning? (Retirement Plans, p. 565)

Wealth management retirement planning positions retirement resources so they conform to future planned objectives. Assets are thoughtfully configured to produce retirement income when the distribution phase of retirement commences. There is thought and planning concerning the transition necessary to strategically move into the distribution phase at retirement. A focus on strategic planning is a hallmark of the wealth management process.

What information is conveyed by the standard deviation with a normal distribution? (Retirement Plan Investing Essentials, p. 53)

With a normal distribution, once we know the standard deviation, the probability that a particular outcome will be above (or below) a specified value can be determined. Specifically, with a normal distribution, 68.3% of values fall within one standard deviation (1 or 2) of the mean, and 95% (99%) fall within two (three) standard deviations of the mean.

Assuming the risk of each security is 0.20 and the risk of all securities is independent, what is the portfolio risk when a portfolio consists of (a) 16 securities or (b) 49 securities? (Retirement Plan Investing Essentials, pp. 77-79)

a. 0.20/16 (1/2 above the 16) =0.05 b. 0.20/49 (1/2 above the 49)=0.0286

How do benefits accrue in a pension equity plan as compared to a cash balance

plan or traditional defined benefit plan? (Retirement Plans, pp. 384-385) In the case of pension equity plans, benefits build steadily but in steps, since credit percentages increase as participants move from one age bracket to the next age bracket. The age-weighted brackets of pension equity plans often increase the rate of accrual with age. In contrast to cash balance plans, pension equity plans are more favorable to older workers and persons hired at midcareer who have fewer years to accrue benefits. Yet the effect of age weighting is not likely to tilt benefit accrual toward later years as significantly as a traditional defined benefit plan.

What type of information should be elicited in a questionnaire sent to prospective investment managers? (Retirement Plans, p. 453)

(a) Portfolio strategies and tactics (b) Ownership as well as employee compensation (c) Decision-making procedures (d) List of current clients and specific people to contact for references (e) Names of accounts lost as well as those gained in recent years (f) Historic performance of each class of assets managed (g) Explanation of exactly how the firm's performance statistics have been computed.

Briefly describe the following disclosure documents required under Title I of ERISA. (Retirement Plans, pp. 501-502)

(a) Summary plan description (SPD): The SPD is the booklet, folder or binder that describes the plan and is given to employees. (b) Summary of material modification (SMM): The SMM is a summary of any plan amendment or change in information that is required to be included in the SPD after the initial SPD has been issued. (c) Summary annual report (SAR): The SAR is a summary of the plan's annual financial report. (d) Benefits statements: The benefits statement is a personalized statement that must be provided to a participant either upon request or at specific intervals for various types of retirement plans.

With financial markets across countries becoming more integrated, should investors ignore international diversification? (Retirement Plan Investing Essentials, pp. 101-102 and 105-106)

A leading authority on international investing believes that the correlation-based argument of risk diversification is very simplistic and dated and that investors must take a global approach in all aspects of their investment management.

How do the studies of behavioral finance and behavioral economics have relevance to retirement plan design as the private retirement system places greater emphasis on defined contribution structures? (Retirement Plans, pp. 188-190)

Behavioral finance and behavioral economics are fields of study that apply the use of scientific research techniques to understand social, cognitive and emotional biases that affect and influence economic decision making. These fields of study concentrate on the decisions of individual and collective economic agents and study whether the decisions they make are entirely rational or seem to lack rationality. Since the trend in retirement plan design has shifted to a defined contribution model where individual plan participants are largely responsible for making investment decisions and bearing the risk associated with those decisions, the field of behavioral finance is highly relevant to plan sponsors to understand the biases that may either help or hinder the decision making that will contribute to plan participant long-term economic security.

What are the consequences for an ERISA fiduciary if a prudently made investment in an ERISA-qualified plan is a failure and money is lost? (Reading B, Prudent Management of Innovative Investments in ERISA Plans, Study Guide Module 10, p. 33)

ERISA requires only that the trustees or fiduciaries vigorously and independently investigate the wisdom of a contemplated investment. It does not matter whether the investment succeeds or fails, as long as the investigation is "intensive and scrupulous and discharged with the greatest degree of care that could be expected under all the circumstances by reasonable beneficiaries and participants of the plan."

What factors have contributed to the shift toward enhanced investment opportunities in DC plans? (Retirement Plans, p. 549)

Many factors have contributed to the creation of enhanced investment opportunities in DC plans. Among the major factors are: (a) A growing public awareness of the role of DC plans in providing economic security and of the importance of saving and investing wisely (b) An increased recognition on the part of employers of the need to provide flexibility of choice and investment education (c) Improved and more efficient administrative capabilities (d) The aggressive marketing efforts of the leading mutual funds.

How is a regulated investment company taxed for federal income tax purposes? (Retirement Plan Investing Essentials, pp. 3-4)

Most regulated investment companies pass on their earnings each year in the form of dividends, interest and realized capital gains to their shareholders. The investment company acts as a conduit, with distributions flowing through to shareholders who pay the taxes. Note that a fund's shareholders are responsible each year for paying taxes on the distributions they receive from an investment company whether they receive the distributions in cash or have them reinvested in additional shares.

What are new comparability plans? (Retirement Plans, p. 391)

New comparability plans are a set of plan types that are similar to age-weighted profit-sharing plans. However, these plans take a further step when directing plan allocations by dividing participants into separate allocation groups (or rate groups) to provide larger percentage contributions to select participants. Plan sponsors have wide latitude in the criteria used to establish allocation groups, such as job descriptions, ownership interest, age and length of service. Furthermore, plan sponsors have flexibility in determining how the allocation process will work under these plans.

Are hybrid retirement plans a distinct structural category like a defined benefit or defined contribution type of plan for tax qualification purposes? Explain. (Retirement Plans, p. 379)

No. While hybrid plans come in several types and plan designs, each is considered either a defined benefit or a defined contribution plan for the purposes of tax qualification.

What are the reasons for the growth of target-date funds (TDFs)? (Reading B, Evaluating and implementing target-date portfolios, Study Guide Module 7, p. 23)

One reason for the growth is that TDFs are a means to simplify the retirement investment decisions of plan participants. Another reason is the designation by the U.S. Department of Labor of TDFs as one type of qualified default investment alternative (QDIA). TDFs are the most popular default investment options of plan sponsors that have added or are adding an automatic enrollment feature to their 401(k) plans. In addition, a number of plan sponsors are actively transferring participants into TDFs from other funds in their plan.

How has the Pension Protection Act of 2006 (PPA) provided protection to, and advanced efforts to improve investment outcomes of, DC plan participants? (Retirement Plans, p. 549)

PPA has provided protection to, and advanced efforts to improve investment outcomes of, DC plan participants through provisions that facilitate a plan sponsor's ability to provide investment advice, require investment diversification for DC plans and permit fiduciary exemption associated with automatic plan enrollment.

Summarize changes in the law affecting retirement plan distribution options occurring as a result of passage of the Pension Protection Act (PPA). (Retirement Plans, pp. 595-596)

PPA made some changes in the law affecting plan distributions and rollovers from various retirement plans. (a) PPA made changes to the mortality table and interest rate that is used to compute the minimum value of a lump-sum distribution paid from a DB plan. The effect of these changes generally was to reduce the value of the lump sum that would be paid under prior law. (b) In the past, distributions to plan participants from a qualified plan before severance of employment were problematic. This issue caused difficulties in facilitating phased retirement arrangements for workers nearing retirement. PPA made clear that a qualified plan could provide distributions to an employee who attains the age of 62 even though the employee has not separated from service. (c) PPA directed the Secretary of the Treasury to change regulations regarding hardship withdrawals from qualified plans, tax-sheltered annuities, nonqualified deferred compensation plans and deferred compensation plans of state and local governments and tax-exempt organizations. With the adjustment in these regulations, distributions for hardships and unforeseen financial emergencies that were previously allowed for conditions affecting spouses and dependents of plan participants were extended to a participant's beneficiary under the plan. This provision is especially helpful in situations involving hardship withdrawals for the payment of medical expenses. (d) PPA waived the 10% early withdrawal penalty tax on qualified public safety employees who separate from service with their employers and take distributions from government pension plans after having attained the age of 50. Similarly, the PPA waived the 10% early withdrawal penalty tax to qualified reservists called to active duty. (e) PPA allowed rollovers from various types of retirement savings plans to be directly placed into Roth IRAs rather than having to first be moved into a traditional IRA, as was previously the case. (f) PPA permitted the rollover of after-tax contributions through a trustee-to-trustee transfer from a qualified retirement plan to a DB plan or a 403(b) plan. After-tax rollovers, although previously allowable into DC plans and IRAs, had not been permitted into DB plans or 403(b) plans prior to January 1, 2007. (g) PPA allowed a non-spouse beneficiary to receive a distribution from an eligible retirement plan previously held by a deceased participant or account owner. Such a distribution must occur through a direct trustee-to-trustee transfer into an IRA created to receive the distribution on behalf of the beneficiary. When such a distribution occurs, the transfer is considered an eligible rollover distribution. The IRA that received the distribution is treated as an inherited account, and the required minimum distribution rules applicable where the participant or account owner dies before the entire interest is distributed apply. The Internal Revenue Service (IRS) issued guidance explaining the rules that dictate how fast money needed to be withdrawn from the IRA. This guidance has substantial implications on the time limit in which tax-deferred (or tax-free for a Roth) compounding occurs, dramatically affecting wealth accumulation within a nonspouse IRA.

Explain how PPA modified filing requirements in connection with a plan's annual financial report to make this information more accessible to parties interested in this information. (Retirement Plans, p. 502)

PPA modified filing requirements in connection with the plan's annual financial report (filed using Form 5500) to make this information more accessible and readily available to parties interested in this information. PPA requires that certain annual report information be filed in an electronic format for Internet display by DOL. DOL must post the information to the Internet website within 90 days of the filing. This information must also be displayed on any employee intranet website maintained by the plan sponsor.

What is contained in a plan document, and do participants and beneficiaries have access to this document? (Retirement Plans, p. 506)

Plan documents include the text of the actual plan itself and any collective bargaining agreement, trust agreement, contract or other document under which the plan is established or operated. Plan participants and beneficiaries are entitled to receive copies of these documents within 30 days of making a written request. DOL may request copies of these documents at any time.

What is the relationship between total return and return relative? (Retirement Plan Investing Essentials, p. 42—Example 2-4)

Return relative adds 1.0 to the total return in order that all returns can be stated on the basis of 1.0 (which represents no gain or loss), thereby avoiding negative numbers so that the cumulative wealth index or the geometric mean can be calculated.

Is there a maximum average maturity limit on what constitutes a money market fund? (Retirement Plan Investing Essentials, p. 11)

SEC regulations limit the maximum average maturity of money market funds to 90 days.

How does a floor-offset plan differ from other types of hybrid retirement plans? (Retirement Plans, p. 392)

The floor-offset plan differs from other hybrids because it is actually two separate plans, a defined benefit plan and a defined contribution plan, working to complement one another. The defined benefit plan establishes a minimum level (floor) of benefit that participants will receive if the defined contribution benefit does not exceed the minimum (floor) benefit. Upon retirement, a given participant's benefit is the amount accumulated in the defined contribution plan if that amount meets or exceeds the minimum (floor) benefit. If the benefit accumulated in the defined contribution plan is less than the minimum (floor) benefit, the difference between the defined contribution account balance and the minimum (floor) is paid by the defined benefit floor plan.

Discuss the following universal retirement wealth management principles in theory and practice. (Retirement Plans, pp. 577-579)

The following guiding principles generally should be considered in managing retirement wealth both during the accumulation phase and throughout the subsequent distribution phase in retirement: (a) Comprehensive diversification: A comprehensive and holistic approach generally should be utilized when conducting asset allocation. Individuals should diversify and look at the entire set of investments along the same investment time horizon; in addition, asset allocation should use a comprehensive perspective. Failing to use this comprehensive approach could result in under- or overallocating to specific asset classes. This assumes, however, that all of the assets are being accumulated to support retirement resource needs. This may not be the case. If an individual is earmarking certain assets for college funding, these assets must be accessed within a targeted time period when education expenses become due. Consequently, it would be problematic to use a comprehensive approach since these assets have been segregated with a specific purpose for their use. (b) Attainable efficiencies should be sought: When accumulating resources for retirement, an individual can capture certain efficiencies during the accumulation process. These efficiencies can occur from different sources. For instance, the very nature of retirement savings vehicles confers tax savings through tax deferral. In addition to tax savings, certain retirement savings vehicles offer lower costs to retirement savers. Sometimes these costs are further reduced when individuals achieve a certain asset size within their accounts. When an individual is starting his or her retirement savings program, vigilance for these savings and the effect of compounding on the individual's savings can appreciably enhance wealth accumulation. (c) Duplication of benefits should be eliminated: The functional approach to employee benefits entails the use of an integrated approach, where employers look for overlap in plan offerings and attempt to eliminate duplication of coverage so as to better utilize limited resources in providing a broad scope of benefit protections addressing the diverse needs of their workforce. As employees have become more empowered in the selection and management of their retirement resources, this same exercise is relevant from an individual perspective. An individual should compare his or her benefit needs and the sources available to address these needs. For instance, an individual may determine that various survivorship needs are applicable because of family circumstances. Some of this need is addressed through social insurance sources. Specifically, Social Security provides survivor benefits to a worker's family. Elimination of redundant or duplicated coverage can be a source of funds for retirement wealth creation. (d) Traditional assumptions warrant questioning: Sometimes individual circumstances warrant deviation from traditional wisdom. For instance, it is generally preferable to use tax-deferred vehicles to save for retirement. This is the preferred wealth-creation strategy in most circumstances. However, there can be situations when deviation from this strategy results in greater wealth building. An individual with large tax deductions related to such things as mortgage expense may actually be in a lower marginal tax bracket than he or she will experience in retirement. If the individual were to have access to investment options within a retirement savings plan where asset values are deeply undervalued or discounted, it may be advisable to pay taxes currently. Under these conditions, it may be preferable to purchase these assets as investments through a Roth IRA, Roth 401(k), Roth 403(b) or Roth 457(b).

Name the four basic types of mutual funds. (Retirement Plan Investing Essentials, p. 10)

The four basic types of mutual funds are: (1) Money market mutual funds (2) Equity (stock) funds (3) Bond funds (4) Hybrid or balanced (stock and bond) funds.

List the four conditions necessary for an efficient market. (Retirement Plan Investing Essentials, p. 147)

The four conditions necessary for an efficient market are: (1) A large number of rational, profit-maximizing investors who are price takers; that is, one person alone cannot affect the price of a stock. (2) Information is costless and widely available to market participants at about the same time. (3) Information is generated in a random fashion. (4) Investors react quickly and fully to new information.

Explain the concept of managing retirement assets using a wealth management approach. (Retirement Plans, p. 564)

The idea of managing retirement assets using a wealth management approach involves holistic decision making to achieve better overall results for an individual's total accumulated wealth rather than making retirement plan decisions in isolation. For example, if a plan participant only makes asset allocation decisions for the assets held in the employer-sponsored retirement plan, he or she may under- or over-allocate assets to specific asset classes. If that individual were to examine total investable assets, the targeted asset allocation occurring in the retirement plan is likely to be quite different. Other decisions also can be made using this wealth management approach.

A U.S. investor bought some Canadian stock for C$250 when the value of the Canadian dollar stated in U.S. dollars was $0.80. One year later, the stock is selling for C$300, and Canadian dollars are now at $0.70. No dividends were received. What was the return relative? (Retirement Plan Investing Essentials, pp. 42-44— Example 2-6)

The increase from 250 to 300 is 50, and 50 divided by 250 is an increase of 20%. In other words, the stock went up 20%, and the return relative is 1.20.

How do the defined benefit and defined contribution plans interact to balance risk and reward under a floor-offset hybrid retirement plan? (Retirement Plans, p. 393)

The interaction of two plans under a floor-offset plan is important. Establishing a reasonable floor benefit level is a balancing act. If the floor benefit guaranteed by the defined benefit plan is not high enough, it may encourage excessively risky investment behavior by participants. On the other hand, a reasonable floor may help encourage some risk-averse participant investors to accept more of the risk required to generate the returns necessary for retirement security.

According to the efficient market hypothesis or concept, what is the primary factor in determining stock prices? (Retirement Plan Investing Essentials, p. 146)

The key to the determination of stock prices and the central issue of the efficient market concept is information.

What are four factors impeding successful individual retirement planning that life-cycle funds address? (Reading A, An Overview of Life-cycle Funds, Study Guide Module 7, p. 17)

The life-cycle investment strategy addresses the following four factors that have been found to hinder successful individual retirement planning: (1) Investors are not inclined to be actively engaged. (2) Investors are overwhelmed by too many fund choices. (3) Investors have limited basic investment knowledge. (4) Investors have limited interest in investment issues.

What is the major practical problem in using the Markowitz portfolio selection model? (Retirement Plan Investing Essentials, pp. 88-90)

The major practical problem with using the Markowitz model is that it requires a full set of covariances between the returns of all securities being considered in order to calculate portfolio variance. There are [n (n - 1)]/2 unique covariances for a set of n securities. For example, with 200 securities, there are 19,900 unique covariances.

What is a closed-end investment company? (Retirement Plan Investing Essentials, pp. 4-5)

The oldest form of the three major types of investment companies, a closed-end investment company offers investors an actively managed portfolio of securities and usually sells no additional shares of its own stock after the initial public offering. Its shares trade in the secondary market exactly like any other stock, with investors using their brokers, paying (or receiving) the current price and paying brokerage commissions.

To what principle can the risk reduction that appears in Learning Objective 1.5 be attributed? (Retirement Plan Investing Essentials, p. 77)

The risk reduction that occurred in Learning Objective 1.5 was a result of the Law of Large Numbers. According to the Law of Large Numbers, the larger the sample size, the more likely it is that the sample mean will be close to the population expected value. Risk reduction in the case of independent risk sources can be thought of as the insurance principle, named for the idea that an insurance company reduces its risk by writing many policies against many independent sources of risk.

Discuss the two measures of risk typically utilized to quantify risk when assessing investment alternatives. (Retirement Plan Investing Essentials, p. 52)

The two measures of risk typically utilized to quantify risk when assessing investment alternatives are variance and standard deviation. Standard deviation is an alternative measure of total risk related to variance and, accordingly, can be calculated from variance. Standard deviation is the square root of variance.

Why are bonds used in pension plan portfolios? (Retirement Plans, p. 450)

The use of bonds in pension plan portfolios typically can be attributed to one of two reasons. First, if the sponsor realizes that (to a large extent) the pension plan's obligations are fixed dollar obligations that will be paid out several years in the future, there may be a desire to purchase assets that will generate a cash flow similar to the benefit payments. Second, the investment manager may be willing to purchase assets with a longer maturity than the money market instruments described above. This assumption of interest rate risk is presumably compensated for by a higher yield than that available from shorter maturities.

Discuss the findings of behaviorists on individual investment decision making, specifically noting the two major categories of impediments that impede rational decision making in this area. (Retirement Plans, p. 190)

Through research, behaviorists have uncovered several insights regarding individual investor patterns of decision making. Some of these insights show a passive avoidance of decision making by individuals, while others show anomalies when individuals make active choices regarding investments. Behaviorists have determined that individuals have certain proclivities and tendencies that forestall them from even approaching the subject and initiating action that is in their long-term interest. But even if individuals surpass the passive factors resulting in inactivity, their active choices are less than optimal and reflect certain active choice biases.

Distinguish between the concepts of total return, return relative and the cumulative wealth index. (Retirement Plan Investing Essentials, pp. 41-42)

While total return and return relative measure changes in the level of wealth, the cumulative wealth index measures the aggregate effect of returns over time given some stated beginning amount.

What are the five requirements for a QDIA? (Retirement Plans, pp. 198-200)

(1) Generally, a QDIA shall not hold or permit the acquisition of employer securities. (2) A QDIA may not impose financial penalties or otherwise restrict the ability of a participant or beneficiary to transfer, in whole or in part, his or her investment from the QDIA to any other investment alternative available under the plan. (3) A QDIA must be managed either by an investment manager as specified under the Employee Retirement Income Security Act of 1974 (ERISA) or by an investment company registered under the Investment Company Act of 1940. The regulation requires that, except in the case of registered investment companies, those responsible for the management of a QDIA be investment managers as defined by ERISA. (4) A QDIA must be diversified so as to minimize the risk of large losses. (5) A QDIA conditions relief on the use of one of three types of investment products, portfolios or services. These three types of investment products, portfolios or services include: • An investment fund product or model portfolio based on the participant's age, target retirement date or life expectancy. An example of such a fund or portfolio may be a lifecycle or target-retirement-date fund or account. • An investment fund product or model portfolio with a target level of risk appropriate for participants of the plan as a whole. An example of such a fund or portfolio may be a balanced fund. • An investment management service where an investment manager allocates the assets of a participant's account based on the participant's age, target retirement date or life expectancy. An example of such a service may be a managed account.

Describe the various forms of money market instruments. (Retirement Plans, p. 449)

(1) U.S. Treasury bills and notes. Treasury bills have maturities at issue ranging from 91 to 360 days, while Treasury notes have initial maturities ranging from one to five years. There is almost no default risk on these investments. In other words, the probability that either interest or principal payments will be skipped is nearly zero. (2) Federal agency issues. The Treasury is not the only federal agency to issue marketable obligations. Other agencies issue short-term obligations that range in maturity from one month to over ten years. These instruments typically will yield slightly more than Treasury obligations with a similar maturity. (3) Certificates of deposit. These certificates are issued by commercial banks and have a fixed maturity, generally in the range of 90 days to one year. The ability to sell a certificate of deposit prior to maturity usually depends on its denomination. The default risk for these certificates depends on the issuing bank, but it is usually quite small. (4) Commercial paper. This is typically an unsecured short-term note of a large corporation. This investment offers maturities that range up to 270 days, but the marketability is somewhat limited if an early sale is required. The default risk depends on the credit standing of the issuer, but commensurately higher yield is available. (5) Money market mutual funds. These funds invest in the money market instruments described above. As a result, investors achieve a yield almost as high as that paid by the direct investments themselves and, at the same time, benefit from the diversification of any default risk over a much larger pool of investments.

a) What is a cash balance plan, and (b) do such plans involve self-directed investments by plan participants in individually allocated accounts? (Retirement Plans, p. 380 and Footnote 7)

(a) A cash balance plan is a defined benefit hybrid retirement plan where the sponsor typically makes plan contributions based on a specified formula that provides an annual contribution credit and applies a fixed interest rate credit. Although this is the typical cash balance design, there can be variations on this benefit design. Some variations include: • Linking benefits to an equities index rather than a fixed rate of return, or • A lower level of guaranteed benefits but profit-sharing elements allowing for increased contributions in periods of superior business performance. Cash balance plans are considered to be career average plans since they typically base contributions on a formula that considers pay in each year of employment. The portable lump sums and relatively early accrual of benefits under these plans are attractive to employees terminating at younger ages and after fewer years of service, while workers with longer service are likely to receive greater benefits from a plan that utilizes a traditional defined benefit formula. (b) Cash balance plans do not involve self-directed investments by plan participants in individually allocated accounts. However, cash balance plans take on the appearance of individually allocated defined contribution accounts, since plan participants receive periodic benefit statements based on hypothetical accounts showing accrued benefit balances. These statements are merely a communication tool, however, since in actuality plan assets are commingled, and their investment is directed by the plan sponsor. The amount of benefit shown on the account statement bears no relationship to actual assets held by the plan.

Describe the relationship between the returns on two securities if the correlation coefficient is (a) +1.0, (b) 0 or (c) -1.0. (Retirement Plan Investing Essentials, pp. 79-83)

(a) A correlation coefficient of +1.0 indicates a perfect direct linear relationship. Combining securities with perfect positive correlation with each other provides no reduction in portfolio risk. (b) A correlation coefficient of 0 shows no relationship between the returns on the securities. Combining two securities with zero correlation with each other reduces the risk of the portfolio. However, portfolio risk is not eliminated in the case of zero correlation. While a zero correlation between two security returns is better than a positive correlation, it does not produce the risk reduction benefits of a negative correlation coefficient. (c) When the correlation coefficient is 21.0, there is a perfect inverse relationship. Combining two securities with perfect negative correlation with each other could eliminate risk altogether.

(a) Why should a plan sponsor establish a formal retirement plan committee, and (b) who comprises the membership of this committee? (Retirement Plans, p. 531)

(a) A plan sponsor should establish a formal retirement plan committee that has responsibility regarding the governance and administration of the retirement plan. While this committee may not be responsible for actually performing any of the administrative functions or handling actual participant communication relative to the plan, the committee does delegate that responsibility to an appropriate party and provides oversight to ensure that the proper actions are happening in a timely fashion. (b) The membership of this committee is generally fairly small. Three to five individuals often are sufficient, and membership consists of key senior leaders of the organization. In a small company, it may consist of the company president and the senior financial and human resources officers. In a larger company, the membership may be the chief financial officer, the human resources vice president and the corporate counsel, plus two other organizational members from senior management.

Describe the specific types of distribution options available when crafting a retirement plan distribution strategy. (Retirement Plans, pp. 587-590)

(a) Annuity payment options: The distinguishing characteristic of an annuity payment option is the guarantee of lifetime income by the plan or the insurer. An insurer can guarantee lifetime income because of the law of large numbers and the operational fact that some payments from the annuity contract will be terminated when a plan participant dies. Annuity options are attractive as retirement plan distribution arrangements because the individual opting for this form of payment cannot outlive the income source. Immediate life annuities convert a single sum of money or an accumulated balance of plan assets into a series of income payments that continue as long as the contract owner(s) (annuitant, or co-annuitants if there is more than one person receiving guaranteed payments) remain living. A deferred life annuity contractually promises to provide a series of payments in the future. There are different types of immediate and deferred annuities. A fixed annuity, usually backed by a portfolio of fixed income investments, guarantees a series of fixed payments. Most fixed annuities provide a stable lifetime income once they are established. Some fixed annuities possess both a guaranteed contractual payment and an incremental portion that can vary to some degree. The nonguaranteed payment from some fixed annuities may change gradually from the initial payment, depending on interest rate movements. A variable annuity provides a periodic lifetime income to annuitants. However, the amount of the annuity payments is not guaranteed. The income provided by a variable annuity varies depending on the performance of the underlying investments in the portfolio. Usually this portfolio consists primarily of equity investments. A variable annuity may keep pace with inflation over longer time horizons. However, the variability associated with this kind of annuity may be a disadvantage, particularly in the short run, if poor performance means a downward adjustment in income payments to annuity owners. (b) Periodic payments: An individual may opt for some form of periodic payment. A person may select payments for a fixed dollar amount or for a fixed number of years. The periodic payment approach would avoid the expenses associated with annuities that compensate an insurer for assumption of longevity risk. A disadvantage of fixed periodic payments is that an individual can exhaust his or her asset base at a future time. If this asset base is the sole or primary means for funding living expenses and the period of disbursement elapses before death, the individual could become indigent. However, if the return on the asset base exceeds that which originally was projected, the individual will either be able to adjust the payment upward or have excess assets to distribute in his or her estate. (c) Intermittent (nonperiodic) payments: An individual may opt to withdraw assets from his or her account on an intermittent or irregular basis. Both with periodic payments and the intermittent payments, investment decisions must be made. If the assets held in the retirement savings plan are generating income, as in the case of bonds, the income routinely may be distributed. If the assets in the account are not generating an income stream, or if the income stream is insufficient to meet the individual's living expenses, decisions must be made concerning the liquidation of assets. (d) Lump-sum distribution: A qualifying lump-sum distribution is a distribution from a qualified retirement plan of the balance to the credit of an employee after age 591⁄2 and within one taxable year of the recipient. The distribution must be made on account of the employee's death, attainment of age 591⁄2 or separation from service. It should be noted that a distribution to the employee in the form of annuity payments after retirement will not prevent the employee's beneficiary from receiving a qualifying lump-sum distribution. Sometimes an employee holds employer securities in a qualified plan. These securities may offer an opportunity for favorable tax treatment that should be considered. When a qualified plan distributes employer securities as part of a lump-sum distribution to employees or their beneficiaries, the net unrealized appreciation (NUA) on any employer securities included as part of the lump-sum distribution qualifies for special tax treatment. (e) Lump sum with rollover: Oftentimes, rather than subject a rollover to immediate taxation, an individual will roll over qualifying plan assets into an IRA or a single employer-sponsored plan and subsequently take distributions from the account. The rollover can be motivated by favorable investment alternatives available within the IRA, an ability to access funds at a lower expense or the desire simply to consolidate assets through a single retirement savings vehicle to facilitate easier management of the assets. Sometimes this centralization of assets can be motivated by the desire to position assets in a single funding vehicle to simplify estate planning. (f) Combining various payment options: Individuals often will examine distinct distribution options without giving adequate consideration to the merits of combining various payment options. It often is preferable to combine various payment options to arrive at a distribution strategy that merges the advantages of these distinct options so as to achieve a more integrated solution for providing retirement income.

As discussed in Whitfield v. Tomasso and Tibble v. Edison International, (a) what elements should be considered in an ongoing monitoring system, and (b) how should plan fiduciaries evaluate the fees associated with innovative investments? (Reading B, Prudent Management of Innovative Investments in ERISA Plans, Study Guide Module 10, p. 33)

(a) As discussed in the aforementioned cases, it was indicated that trustees have an obligation to set up a monitoring system that (1) determines the needs of a fund's participants, (2) reviews the services provided and fees charged by a number of different providers, and (3) selects the provider whose service level, quality and fees best match the fund's needs and financial situation. (b) When investigating innovative investments, fiduciaries must conduct at least two types of fee comparisons (both initial investigation and ongoing monitoring). The first would be to compare the fees of the selected innovative investment against an appropriate benchmark or typical (such as median) expenses for plans with similar characteristics nationally. The second would be the specific manager's fees for the innovative investment as compared to several different vendors or managers in the same type of marketplace. Documentation should be maintained to indicate that fees were reasonable under both types of analysis, with specific emphasis on the cost-benefit ratio and the needs of the plan participant.

Describe the basic types of common stocks. (Retirement Plans, p. 451)

(a) Blue-chip stocks. These are stocks issued by major companies with long and unbroken records of earnings and dividend payments. They should appeal primarily to pension plans seeking safety and stability. (b) Growth stocks. These are stocks issued by companies whose sales, earnings and share of the market are expanding faster than either the general economy or the industry average. They represent a higher risk, but the prospects for capital appreciation should produce a correspondingly higher total return. Because they pay relatively small dividends, they may not be attractive to pension plans with cash flow needs. (c) Income stocks. These are stocks that pay higher-than-average dividend returns. They have been attractive to pension plans that bought stock for current income. (d) Cyclical stocks. These are stocks issued by companies whose earnings fluctuate with the business cycle and are accentuated by it. (e) Defensive stocks. These are stocks issued by recession-resistant companies. These may be an important consideration for pension plans that cannot afford major capital losses. (f) Interest-sensitive stocks. These are stocks whose prices tend to drop when interest rates rise, and vice versa.

For purposes of the law involving prohibited transactions, answer the following questions: (a) who are considered disqualified persons? (b) What transactions between the plan and a party in interest or a disqualified person are prohibited? (c) What penalties are assessed on a fiduciary for any breach or violations of his or her responsibilities? (Retirement Plans, p. 512)

(a) Both labor law (Title I of ERISA) and the Internal Revenue Code (IRC) prohibit certain transactions between the plan and disqualified persons. A disqualified person is broadly defined to include any plan fiduciary; a person providing service to the plan; any employer or employee organization whose employees or members are covered by the plan; a direct or indirect owner of 50% or more of the business interest of the employer; a relative of any of the above; an officer, director and certain highly compensated employees (HCEs); or a person having 10% or more of the ownership interest in any of the preceding. Under ERISA, an employee also is considered to be a party in interest; an employee, however, is not considered to be a disqualified person. (b) The following transactions between the plan and a party in interest or a disqualified person are prohibited: • The sale, exchange or leasing of property • Lending money or extending credit (including funding the plan by contributing debt securities) • Furnishing goods, services or facilities • A transfer or use of plan assets • The acquisition of qualifying employer securities and real property in excess of allowable limits. These prohibitions apply even to "arm's length" transactions and even though the plan is fully protected. Under ERISA, a fiduciary will be personally liable for any breach or violation of responsibilities and will be liable to restore any profits made through the use of plan assets. Under IRC, an excise tax of a percentage of the amount involved in a prohibited transaction may be levied on the disqualified person who engages in the transaction. For prohibited transactions occurring after August 5, 1997, the initial excise tax is 15% of the amount involved. If the situation is not corrected within the time allowed (90 days unless extended by the Internal Revenue Service (IRS)), a further excise tax of 100% of the amount involved may be imposed. However, engaging in a prohibited transaction will not cause the plan to be disqualified.

(a) Describe the basic rule under which retirement plan distributions are generally taxed, and (b) explain the elements that constitute an employee's cost basis or investment in contract for tax purposes. (Retirement Plans, pp. 597-599)

(a) Broadly speaking, distributions from a qualified plan are taxable in accordance with the annuity rules of Section 72 of the Internal Revenue Code (IRC). Lump-sum distributions made to individuals born before January 1, 1936 may qualify for special income-averaging treatment if certain conditions are met. (b) It is important to have a clear understanding of the elements that constitute an employee's cost basis (or investment in contract), if any, since the employee's cost basis is an important factor in the taxation of distributions under the plan. Briefly, Section 72 of IRC provides that an employee's cost basis includes the following: • The aggregate of any amounts the employee contributed on an after-tax basis while employed • The aggregate of the prior insurance costs the employee has reported as taxable income, but only for distributions made under that policy. (If the employee has made contributions and the plan provides that employee contributions will first be used to pay any cost of insurance, the employee's reportable income for any year is the excess, if any, of the insurance cost of protection over the amount of the employee's contribution for the year, and not the full cost of insurance protection.) • Other contributions made by the employer that already have been taxed to the employee. For example, an employer has maintained a nonqualified plan that later was qualified. • Loans from the qualified retirement plan to the participant that were treated as taxable distributions. There also is provision for the inclusion of other items in an employee's cost basis, such as contributions made by the employer after 1950 but before 1963 while the employee was a resident of a foreign country. For the most part, however, the items listed above will constitute an employee's cost basis in the typical situation.

Describe how the following forces have served to support a paradigm shift where individuals are more likely now to use a wealth management approach in managing their retirement assets. (Retirement Plans, pp. 567-568)

(a) Change in the employer-employee employment contract: The employer-employee employment contract has changed over time. In the past, many employers perceived the employer-employee employment contract as a longer term, enduring relationship. Most often in the past, the retirement plan of choice was a defined benefit plan, and the intended result was to continue a percentage of final pay determined by using specific income replacement ratios targeted at the pension plan's inception. In today's labor markets, such long-term, enduring employment relationships are far less common. Consequently, the design and features of retirement plans are very different from the plans that popularized this prior era. Employers have substituted defined contribution plans and leave the future management of plan assets to the individuals who have received plan contributions from their employers. (b) Change in governmental policy: Changes in governmental and tax policy have allowed employees to exercise greater authority over plan selections. Public policy has moderated to bring more uniformity to plan structures, and increased portability has allowed plan participants to aggregate assets from these multiple plans in an employer-sponsored plan or an individual retirement account (IRA). Governmental policy has supported a system that allows the individual participant to play a larger role in controlling his or her personal assets accumulated from a variety of employers during a career. (c) Marketplace forces and competition by market participants: Entrance of new participants into various market sectors has brought the introduction of new products and services in the retirement planning area. The presence of insurance companies, mutual funds, trust companies, other asset managers and recordkeepers has meant innovation in the plan offerings for employers and increased competition to provide administrative services to employer-sponsored retirement plans. Employee benefit consultants also have been influential in assisting employers in ensuring plan compliance and innovating plans to capitalize on the latest options and features permitted by law. With many changes in the law requiring compliance, employers found it difficult to stay current with legally required modifications to their plans. As more employee benefit consulting firms and asset managers moved to provide outsourced administrative services to plans, more employers have seen that employee benefit plan administration most often is not an organizational core competency. This recognition, along with the expertise, high-quality services and cost savings resulting from economies of scale provided by these vendors, have resulted in a movement of plan administration to external vendors. Providing these specialized administrative services has increased the pace at which innovation has moved into employer-sponsored retirement plans. (d) Enhancements in technology and recordkeeping services: All the administrative change affecting retirement plans could not have occurred without advances in technology. Improved technology and innovations in recordkeeping services have facilitated this more flexible and portable system.

a) How do benefit accrual rates differ between cash balance plans and traditional defined benefit plans, and (b) how do the benefit accrual rates under cash balance plans appeal to various workforce groups? (Retirement Plans, pp. 383-384)

(a) Compared with the traditional defined benefit plans they often replace, more benefit accrual typically takes place in earlier years of service for participants of cash balance plans. (b) Combining earlier benefit accrual with portability makes cash balance plans more favorable to younger, more mobile workers. Conversion to a cash balance plan from a traditional defined benefit plan could negatively affect the benefits of midcareer or older workers who had begun to accrue sizable benefits in a traditional defined benefit plan. As explained in Learning Objective 4.2, provisions enacted into law as part of the Pension Protection Act of 2006 (PPA) have mitigated some of the adverse consequences related to conversion to a cash balance plan from a traditional defined benefit plan.

Describe (a) the disclosure requirements mandated by DOL that plan sponsors must provide to all plan participants and beneficiaries if target-date funds (TDFs) are offered under a defined contribution retirement plan and (b) the expanded, additional disclosures that were generally required for QDIA when the TDF requirements were instituted. (Retirement Plans, p. 202)

(a) DOL mandated that disclosures be made by plan sponsors to all plan participants and beneficiaries if TDFs are offered under a defined contribution retirement plan. These disclosures must be made to the participants and beneficiaries regardless of whether or not the participants and beneficiaries have actually been defaulted into a TDF. Among the required disclosures are: • An explanation of the TDF's asset allocation, how it will change over time and the point at which the investment will reach its most conservative asset allocation, including a chart, table or other graphical representation. • An explanation, if the fund by name includes or implies a target date, of the age group for whom the investment is designed, the relevance of that date, and any assumptions about a participant's contribution and withdrawal intentions on or after such date. • A statement that the participant may lose money by investing in a TDF, including losses near and following retirement, and that there is no guarantee that the investment will provide adequate retirement income. (b) In addition to the disclosure requirements mandated for TDFs, DOL required expanded, additional disclosures for qualified default investments. Among these expanded, additional disclosures were: • The name of the QDIA issuer • The investment objectives or goals • A description of the investment's principal strategies and risks • Historical performance data and, if applicable, any fixed return, annuity, guarantee, death benefit or other ancillary features • A statement indicating that an investment's past performance is not necessarily an indication of its future performance • A description of fees and expenses, including those charged directly against the amount invested in connection with acquisition, sale, transfer or withdrawal (e.g., sales loads, sales charges, deferred sales, surrender charges, redemption fees, exchange fees, account fees and purchase fees) of any annual operating expenses (e.g., expense ratio) as well as any ongoing expenses in addition to annual operating expenses (e.g., mortality and expense fees).

Describe (a) what features defined benefit hybrid plans possess that are characteristic of traditional defined benefit plans and (b) what features these plans possess that are typically associated with defined contribution plan structures. (Retirement Plans, p. 380)

(a) Defined benefit hybrid retirement plans possess certain features that are characteristic of traditional defined benefit plans. These plans promise a specific benefit level for participants, and plan sponsors manage the investing of plan assets through commingled funds. Hence, the plan sponsor bears the investment risk and reaps the benefit of investment rewards should these occur. Defined benefit hybrid plan structures make it relatively easy for plan sponsors to integrate the plan with Social Security and target income replacement ratios. These plans offer distributions in the form of annuities and are subject to Employee Retirement Income Security Act (ERISA) requirements such as minimum standards for eligibility, vesting and funding. Annual actuarial valuations are required, as is payment of plan termination insurance premiums to the Pension Benefit Guaranty Corporation (PBGC). b) Defined benefit hybrid plans also possess certain features that are characteristic of traditional defined contribution plans. In addition to allowing for distribution of benefits in an annuity form, defined benefit hybrid plans express benefits in terms of lump-sum values and, at times, also offer lump sums as a distribution option. This feature, which makes for portability and benefits expressed in terms of lump-sum values, typically makes these hybrids of greater appeal to younger and more mobile workers.

Distinguish between various types of (a) equity funds, (b) taxable bond funds and (c) tax-exempt bond funds, as categorized by the Investment Company Institute (ICI). (Retirement Plan Investing Essentials, p, 13, Exhibit 1-1)

(a) Equity funds include the following types of funds: • Capital appreciation funds seek capital appreciation; dividends are not a primary consideration. • Total return funds seek a combination of current income and capital appreciation. • World equity funds invest primarily in stocks of foreign companies. (b) Taxable bond funds include the following types of funds: • Investment grade funds seek current income by investing primarily (65%) in investment grade debt securities. • High-yield funds seek current income by investing two-thirds or more of their portfolios in lower rated corporate bonds. • Government bond funds pursue an objective of high current income by investing in taxable bonds issued, or backed, by the U.S. government. • Multisector bond funds seek to provide high current income by investing predominantly in a combination of domestic securities, including mortgage-backed securities and high-yield bonds, and may invest up to 25% in bonds issued by foreign entities. • World bond funds seek current income by investing in the debt securities of foreign companies and governments. (c) Tax-exempt bond funds include the following types of funds: • National municipal bond funds invest in a national mix of municipal bonds with the objective of providing high after-tax yields. • State municipal bond funds invest primarily in municipal bonds issued by a single state. The bonds are exempt from federal income tax as well as state taxes for residents of that state.

Describe the benefits of a successful investment program for (a) the employer and (b) the employees. (Retirement Plans, p. 548)

(a) For the employer, the benefits of a successful investment program include: • Low-cost fees • Ease of administration • Flexibility to make needed changes in investment arrangements • Improved recognition of the company as a source of valuable benefits. (b) For employees, a well-executed investment program maximizes capital accumulation through: • Increased participation • Improved returns • Lower costs.

Discuss the relevant penalties provided under ERISA should a plan sponsor violate the disclosure requirements imposed by the law. (Retirement Plans, p. 509) ERISA provides for a number of penalties for violation of the disclosure requirements. Among the penalties are the following:

(a) If a plan administrator does not fill a participant's or beneficiary's request for information to which he or she is entitled under the plan within 30 days, the plan administrator may be personally liable to the individual who made the request for a fine of up to $112 per day. (b) Willful violation of any of the reporting and disclosure provisions may incur a criminal penalty of up to a $5,000 fine and/or one year in prison for an individual and up to a $100,000 fine for a corporation. (c) Civil actions may be brought against the plan administrator by participants or beneficiaries to obtain information to which they are entitled under their plan, to enforce their rights under the plan or to clarify their rights to future benefits under the plan. (d) Civil action also may be brought by the Secretary of Labor, a participant, a beneficiary or another fiduciary against an individual who breaches his or her fiduciary duty. It is expected that random audits will be performed continually and that a team of investigators will follow up on all discrepancies found and all complaints filed by plan participants or beneficiaries. Records now are required to be kept for a period of six years after the documents are due for filing, even for those plans that are exempt from filing.

What is the relationship between a passive investment strategy for common stocks and (a) the efficiency of markets, (b) the return objective and (c) transaction costs? (Retirement Plan Investing Essentials, p. 126)

(a) If the market is totally efficient, no active strategy should be able to beat the market on a risk-adjusted basis. The greater the efficiency of the market, the greater the merit of passive investing. (b) The investment objective of a passive strategy is to simply do as well as the market. (c) With a passive strategy, the goal is to minimize transaction costs because the benefits of active trading are not likely to be worthwhile.

Define each of the following. (Retirement Plan Investing Essentials, pp. 50-51)

(a) Interest rate risk Interest rate risk is the variability in a security's returns caused by changes in the level of interest rates. Other things being equal, security prices (especially bonds) move inversely to interest rates. Interest rate risk affects bonds more directly than common stocks, but it affects both types of securities and is a very important consideration for most investors. (b) Market risk Market risk is the variability in returns caused by fluctuations in the overall market. All securities are exposed to market risk, although it affects primarily common stocks. Market risk includes a wide range of factors including recessions, wars, structural changes in the economy and changes in consumer preferences. (c) Inflation risk Inflation risk is the chance that the purchasing power of invested dollars will decline. It affects all securities even if the nominal return is safe (e.g., a Treasury bond). This risk is related to interest rate risk, since interest rates generally rise as inflation increases, because lenders demand additional inflation premiums to compensate for the loss of purchasing power. (d) Business risk Business risk is the risk of doing business in a particular industry or environment. For example, AT&T, the traditional telephone powerhouse, faced major changes in the rapidly changing telecommunications industry when alternatives became available. (e) Financial risk Financial risk is the uncertainty of returns caused by the use of debt. The larger the proportion of a company's assets that is financed by debt (as opposed to equity), the larger the variability in the returns, other things being equal. (f) Liquidity risk Liquidity risk is the uncertainty of being able to sell an investment quickly and without significant price concession. (g) Currency risk (exchange rate risk) Exchange rate risk is the variability in returns caused by currency fluctuations. (h) Country risk Country risk is the political risk that the country may not be economically stable.

Explain the following retirement plan innovations resulting from behavioral finance findings: (a) lifecycle funds, (b) progressive increases in savings rates, (c) automatic enrollment and (d) default investments. (Retirement Plans, pp. 195-197)

(a) Lifecycle funds are mutual funds to facilitate asset allocation decisions based on the participant's age. There are two basic types: static-allocation funds : With the static-allocation approach, the funds maintain an established asset allocation. A series of funds are offered, with some funds aggressive and other fund offerings having less risk. Investors determine which fund is appropriate given their individual risk tolerances. Individuals often use more aggressive funds at younger ages and transition into the less aggressive funds as they age and approach retirement. targeted-maturity funds: The second approach offers a series of funds with target retirement dates designated. An individual selects a fund with the approximate or exact year in which he or she expects to retire. Unlike the static-allocation funds, where an individual must actively choose to move to less aggressive funds as he or she approaches retirement, the targeted-maturity funds automatically rebalance and shift investments from aggressive to more conservative asset allocations as the target date approaches. The final allocation as of the targeted date is often intended to remain intact throughout the retirement years. (The next module in this course, Module 7, delves deeply into the use of these lifecycle funds in retirement plan design.) (b) Under the progressive increases in savings rates approach (suggested by Thaler and Benartzi), decisions are made considerably in advance of pay raises to commit to increased retirement savings at those future times when pay is raised. (c) The practice of automatic enrollment involves a requirement that an individual becomes a plan member when initially eligible unless the individual makes a negative election to the contrary to decline plan participation. This approach requires action by the individual to decline participation rather than the traditional approach that requires action in order to become a plan member. (d) Default investments are closely related to automatic enrollment. A contribution into a defined contribution plan that is self-directed by the employee presents a problem. Once a contribution is placed in the plan, how should the contribution be invested? In the absence of instructions from the employee, should the employer make investments that were unlikely to sustain any losses? Or, alternatively, should an employer invest using asset classes whose historical rate of return would provide a superior long-term outcome, though possibly with greater volatility, resulting in investment losses in the short term? The passage of the Pension Protection Act of 2006 (PPA) brought greater clarity to this issue.(See Learning Objectives 5.2 through 5.4 below.)

Describe the wealth-building opportunities represented by the following. (Retirement Plans, pp. 580-581)

(a) Means to diversification: Diversification is an important component in managing investment risk. Because retirement plan assets need not be accessed until a distant date in the future, diversification need not be continuously maintained throughout the entire period of accumulation. If certain asset classes are thought to be undervalued in the market, a higher weighting can be given to these asset classes, and some degree of portfolio concentration can be tolerated in the short run to enhance longer term rewards. (b) Dollar cost averaging: Dollar cost averaging is a method of regular, systematic investing in which an individual invests the same dollar value on a periodic basis, usually monthly, in equity investments regardless of whether the valuation of these equities is considered to be undervalued, overvalued or fairly valued. The dollar cost averaging approach is appealing because it avoids some of the emotional pitfalls that individuals can succumb to. Typically, an individual purchases more shares when the market is cheaper and buys fewer shares when the market is more expensive. This method is particularly easy to apply to retirement plan investing because of the regularity of investment that accompanies the payroll cycle. (Although widely recommended, some recent studies suggest some other modified investment approaches may be superior to this traditional investment method.) (c) Risk transfer at favorable pricing: Given the retirement risks, it is sometimes a preferable risk management strategy to transfer some of these risks. For the individual planning for retirement, this is often accomplished through the purchase of insurance. Risk transfer can occur by using life insurance, health insurance and long-term care insurance. Retirement income risks and investment risks can be transferred by purchasing an annuity or by opting for a retirement distribution in an annuity form. When these products are priced favorably, they should be considered. (d) Strategic asset positioning: Sometimes the selection of specific assets within certain retirement savings plans can enhance wealth creation. For example, a corporate stock paying a substantial dividend would normally be subject to ordinary income taxation on the dividend. The purchase of this same stock within a self-directed Roth IRA would mean a high tax-free yield if withdrawals in future periods met the stipulations for a qualified distribution. (e) Preemptive tax planning: Anticipating the tax consequences of strategic actions can result in individuals selecting the optimal alternative. Tax consequences have such important impacts on retirement planning strategies that they should always be considered. This is especially true concerning the distribution of income from retirement savings plans. (f) Beneficiary planning: The assets held in retirement plans typically represent a substantial component of a decedent's net worth. Because of the substantive size of retirement accumulations and the importance of these assets for the maintenance of living standards for spouses and other designated beneficiaries, the designation of the beneficiary for these resources should be carefully considered. Retirement plan assets give rise to income in respect of a decedent (IRD). IRD occurs when a deceased person was entitled to items that would have created gross income for federal income tax purposes but that were not includable in the decedent's gross income for the year of his or her death. IRD items are generally treated as gross income to whoever receives them after the decedent's death. They do not receive a step-up in basis following the decedent's death, as do capital assets at present. Accordingly, these assets can be subject to substantial taxation. Also, because of the ability of assets within these plans to compound on a tax-deferred basis (or on a tax-free basis for Roth plans), these plans can create substantial wealth. Selection of a beneficiary whose life expectancy extends or stretches the period of favorable tax treatment can result in substantial wealth-building possibilities. (g) Balance between active and passive management: Selecting the investment approach for the assets within retirement savings plans is an important decision. The merit of active versus passive management has been the subject of considerable academic research. Selecting an appropriate and effective investment strategy is a very important strategic consideration with long-term consequences to wealth accumulation. Given the ability to compound investment earnings within retirement savings vehicles by deferring taxes (or avoiding taxes with Roth accounts), these types of plans become a "high-performance engine" for wealth creation. A cost-effective investment strategy yielding positive and competitive performance will increase wealth.

Assume that a portfolio consists of only two stocks, A and B, and that 50% of the funds are invested in each stock. Further assume that the standard deviation of returns is 25% for each stock. What are the implications for portfolio risk if the correlation coefficient between stock A and stock B is (a) +1.0, (b) -1.0 or (c) 0? (Retirement Plan Investing Essentials, pp. 84-85)

(a) Portfolio risk will not be reduced at all. The risk (as measured by standard deviation) will be 25% for Stock A, Stock B and the combined portfolio. (b) Portfolio risk will be eliminated. The risk for Stocks A and B will be 25%, but portfolio risk will be 0%. There will be no fluctuations in returns. (c) With a correlation coefficient of 0, the portfolio risk will be reduced but not eliminated.

Describe the effect that various income distribution approaches may have in the following areas. (Retirement Plans, pp. 594-595)

(a) Reducing taxes: Affecting taxes can be easily demonstrated. For example, suppose an individual decides to move assets from a traditional IRA to a Roth IRA, either because he or she expects tax rates to increase in the future or because he or she wishes to position assets in a tax-free distribution vehicle for the future. Immediate conversion of an entire balance held in a traditional IRA may be very costly from a tax perspective. A full, immediate conversion may cause a significant portion of the accumulation in the traditional IRA to be taxed at a higher marginal tax rate when converted. Full conversion also may cause an individual to lose various tax credits, exemptions and deductions because tax preferences are phased out at higher income levels. An individual who converts a portion of the traditional IRA to the Roth over a period of years could steer the conversion to occur at lower marginal tax rates and avoid the phaseout of beneficial credits, exemptions and deductions. This same principle of subjecting income to higher marginal tax rates and the loss of tax credits and deductions also applies if an individual holds assets in qualified plans on a tax-deferred basis and also holds balances in a Roth IRA or other Roth-type account such as a Roth 401(k) or a Roth 403(b). Varying distributions from these retirement savings plans that receive different tax treatments can reduce taxes and increase disposable income. (b) Reducing risks: Distribution options affect risk retention. Previously, it was shown that annuity distribution options are effective in managing longevity risk. Other distribution options increase and decrease risks as well. One research paper noted differential impacts on risk depending on the way distributions occur. The paper indicated a spending strategy could involve withdrawals to maintain an individual's standard of living and another in which withdrawals are a fixed percentage of the value of the account. In the first case, the ultimate risk is insolvency with the account being exhausted, whereas the second alternative risks a sustained and persistent reduced standard of living below what is really necessary. Combining distribution options also can have an impact on risk because of correlations between risks similar to the correlation between individual securities in an overall portfolio. Researchers have shown that the inclusion of an annuity distribution option with other distribution methods can have a beneficial impact on reducing longevity risk and enhancing portfolio withdrawal stability.

Summarize (a) the tax on early distributions from a retirement plan and (b) the tax on late distributions from a retirement plan. (Retirement Plans, pp. 605-606)

(a) Tax Reform Act (TRA) '86 added an additional 10% tax on any taxable amounts received before age 591⁄2 from a qualified retirement plan. This additional tax on early distributions does not apply in the case of death, disability or termination of employment after age 55. Exceptions also are granted for: • Distributions that are part of a series of substantially equal periodic payments made for the life (or life expectancy) of the employee or the joint lives (or joint life expectancies) of the employee and his or her beneficiary • Distributions used to pay medical expenses to the extent the expenses are deductible as medical expenses for federal income tax purposes. Also, distributions from an IRA used to pay health insurance premiums after separation from employment • Certain dividend distributions made from an employee stock ownership plan (ESOP) • Payments to alternate payees pursuant to a qualified domestic relations order (QDRO) • Distributions from an IRA used to pay qualified education expenses of the taxpayer or his or her spouse, child or grandchild • Distributions from an IRA for the purchase of a first home (limited to $10,000) • Certain other distributions, such as those to pay an IRS tax levy or a timely corrective distribution from the plan • The exceptions described earlier in Learning Objective 5.2 as enacted by PPA. (b) Participants must commence benefit payments by April 1 of the calendar year fol-lowing the calendar year in which they reach age 701⁄2 after terminating employ-ment. If the participant's benefit is determined from an individual account, the minimum amount that must be paid each year is determined by dividing the ac-count balance by the applicable life expectancy. The applicable life expectancy is the life expectancy of the employee or the joint life expectancies of the employee and the employee's designated beneficiary, if any. If the participant's benefit is de-termined by the annuity distribution from a defined benefit plan, the annuity must be paid for in one of the following durations: (1) the life of the participant, (2) the lives of the participant and the participant's designated beneficiary, or (3) a period certain not extending beyond the life expectancy of the participant or the joint life expectancies of the participant and the participant's designated beneficiary. The penalty for failure to make a required distribution of (at least) the correct amount is a nondeductible excise tax of 50% of the difference between the minimum required amount and the actual distribution. This tax is imposed on the payee.

An investment was worth $100 at the end of 2010. At the end of 2011, it was worth $180. At the end of 2012, it was worth $100. During the entire period, no dividends or other income were received from the investment. What is this investment's (a) arithmetic mean rate of return and (b) geometric mean rate of return? (Retirement Plan Investing Essentials, pp. 45-46)

(a) The arithmetic mean rate of return would be calculated as follows: First year: $100 increase to $180 is an 80% increase. Second year: $180 decreasing to $100 is a decrease of 44.44% (i.e., 180-100 = 80, and 80 divided by 180 is 44.44%). The arithmetic average of 180% and -44% is 18%. (b) The geometric mean rate of return is the return that will make the beginning value equal the ending value. It measures the compound rate of growth over time. In this case, the geometric mean return is 0% because it takes no return for$100 to become $100.

a) What was the intent of congressional writers when drafting ERISA Section 404, and (b) what are commonly viewed as "core" prudent best practices arising from this section of ERISA? (Reading B, Prudent Management of Innovative Investments in ERISA Plans, Study Guide Module 10, pp. 30-31)

(a) The legislative history of ERISA Section 404 indicates congressional writers sought to codify long-standing principles of fiduciary conduct developed under the common law of trusts, with the specific intention of protecting participants in employee benefit plans. (b) The following are commonly viewed as "core," or baseline, prudent best practices arising from Section 404 of ERISA: A fiduciary shall discharge his duties with respect to a plan solely in the interest of the participants and beneficiaries and: • For the exclusive purpose of providing benefits to participants and their beneficiaries and defraying reasonable expenses of administering the plan • With the care, skill, prudence and diligence under the circumstances then prevailing that a prudent man acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims • By diversifying the investments of the plan so as to minimize the risk of large losses, unless under the circumstances it is clearly prudent not to do so • In accordance with the documents and instruments governing the plan insofar as such documents and instruments are consistent with the provisions of this subchapter and subchapter III of this chapter.

Compare the two types of lifecycle funds in terms of (a) risk profile, (b) asset allocation shifts, (c) allocation monitoring and (d) time horizon. (Reading A, An Overview of Lifecycle Funds, Study Guide Module 7, p. 19)

(a) Under a targeted-maturity fund, it is assumed that investors who share a retirement date have similar objectives and risk tolerance. Under a static-allocation fund, investors assess their own risk tolerance. (b) Under a targeted-maturity fund, an advisor automatically changes the asset allocation over time. Under a static-allocation fund, the investor decides when and how to shift to a more conservatively allocated fund as retirement draws nearer. (c) Under a targeted-maturity fund, all asset allocation changes occur within the fund. Under a static-allocation fund, periodic monitoring by the investor is necessary to determine whether the fund's asset allocation continues to match the investor's risk profile through the stages of accumulation, transition and retirement. (d) Under a targeted-maturity fund, the time horizon is predetermined, based on the fund's target date. Under a static-allocation fund, investors have flexibility to alter their asset allocations based on their changing time horizon.

What is a collective investment fund, and how does it charge fees when offered as an investment option under a 401(k) plan? (Retirement Plans, p. 540)

A collective investment fund is a trust fund managed by a bank or trust company that pools investments of 401(k) plans and other similar investors. Each investor has a proportionate interest in the trust fund assets. For example, if a collective investment fund holds $10 million in assets, and a participant's investment in the fund is $10,000, the individual has a 0.1% interest in the fund. Like mutual funds, collective investment funds may have different investment objectives. There are no front- or back-end fees associated with a collective investment fund, but there are investment management and administrative fees.

How can a cumulative wealth index be calculated using geometric mean data for asset classes across time periods? (Retirement Plan Investing Essentials, p. 57)

A cumulative wealth index can be calculated for financial asset return series. To calculate cumulative wealth for each of the series considered, merely raise (1 + the geometric mean) to the power represented by the number of time periods. When a cumulative wealth index is calculated using asset classes, common stocks far outpace corporate bonds, U.S. Treasury bonds and U.S. T-bills. However, the variability of the common stock series is considerably larger than that for bonds or T-bills.

What is a defined contribution hybrid plan, and what are the most common types of defined contribution hybrids? (Retirement Plans, p. 389)

A defined contribution hybrid plan combines a defined contribution plan structure with attributes of a defined benefit plan. Commonly, the defined benefit attributes of these plans involve the ability to allocate benefits in favor of specific participant groups or the ability to make plan sponsor contributions that are determined actuarially and are set as fixed obligations. Defined contribution hybrid plans include target benefit plans, age-weighted profit-sharing plans and new comparability plans.

What is a fidelity bond, and how does it offer protection to a plan sponsor? (Retirement Plans, p. 532)

A fidelity bond is a form of protection that covers policyholders for losses that are incurred as a result of fraudulent acts by individuals specified in the bond's contract. All qualified retirement plans are required to have a fidelity bond that covers at least 10% of the plan assets in case of loss to the plan because of criminal acts or embezzlement by any of the plan fiduciaries or other plan officials. The maximum required amount for the fidelity bond is $500,000 unless the plan holds employer securities, in which case the maximum is increased to $1 million. It often is possible to have this fidelity bond added to the corporation's existing fidelity bond, but care should be taken to ensure that the fidelity bond fully complies with Employee Retirement Income Security Act (ERISA) requirements.

Explain the liability of a fiduciary should he or she knowingly participate in or assist a co-fiduciary in committing a violation of fiduciary rules. (Retirement Plans, p. 513)

A fiduciary may be liable for the violations of a co-fiduciary if the fiduciary knowingly participates in or conceals a violation or has knowledge of a violation or by the fiduciary's own violation enables the co-fiduciary to commit a violation. If a plan uses separate trusts, however, a trustee of one trust is not responsible for the actions of the other trustees. Also, a fiduciary will not be responsible for the acts of a duly appointed investment manager (except to the extent that the fiduciary did not act prudently in selecting or continuing the use of the investment manager). A trustee also is not responsible for following the direction of named fiduciaries in making investment decisions if the plan so provides.

What is a key difference between annuities offered directly through a retirement plan and annuities offered through an insurer outside of a retirement plan? (Retirement Plans, p. 591)

A key difference exists between annuities offered directly through a retirement plan and annuities offered through an insurer outside of a retirement plan. This difference involves the mortality table used to compute lifetime income payments. Retirement plan annuities must use unisex mortality tables, where the payments are the same for men and women who have attained the same age. This has been required ever since the Supreme Court so ruled in the case of Arizona Governing Committee v. Norris in 1983. Annuities sold by insurers outside a retirement plan may use different annuity tables for men and women because the life expectancies of women exceed those of men.

Describe how the retirement plan committee delegates responsibilities to other parties concerning the retirement plan. (Retirement Plans, p. 532)

A key function of the retirement plan committee is the delegation of responsibilities to other parties. This includes internal corporate delegation as well as the delegation of certain plan functions to external service providers such as a plan trustee, record-keeper, actuary, investment manager and plan consultant. Although a corporation may hire external entities to provide these services, this does not relieve the plan sponsor of fiduciary responsibility for these functions. Therefore, it is essential that the retirement plan committee understand clearly what these external service providers will and will not be doing relative to the administration of the plan.

What is the difference between a load fund and a no-load fund? (Retirement Plan Investing Essentials, pp. 18-20)

A load fund charges a sales fee (load), currently up to about 5.75%, that goes to the marketing organization that sells the shares. No-load funds are purchased directly from the fund itself and involve no sales charge.

How does a logarithmic scale facilitate comparisons of different series of returns across time? (Retirement Plan Investing Essentials, p. 56, Footnote 14)

A logarithmic scale greatly facilitates comparisons of different return series across time because the same vertical distance represents the same percentage change in a particular series return.

Describe the scope of Title I of ERISA in terms of which types of plans must fulfill its requirements for the disclosure of information and which types of plans are exempt from these requirements. (Retirement Plans, p. 501)

A major aspect of Title I concerns the disclosure of information to participants and their beneficiaries and to the government. These requirements generally apply to most tax-qualified plans regardless of the number of participants involved. There are, however, a limited number of exemptions. They do not, for example, apply to unfunded excess benefit plans, which are maintained to provide employees with benefits they would otherwise have received but that were not provided under the qualified plan because of Section 415 limitations. It should be noted that this exemption is limited in scope and does not, for example, apply to so-called excess benefit plans that restore benefits lost because of the maximum limit on pay that can be taken into account when calculating plan benefits or contributions. Also, if an unfunded plan is maintained for the exclusive benefit of a "select group of management or highly compensated employees," the only disclosure requirement is that DOL be notified of the existence of the plan and the number of employees that it covers.

What is a mutual fund? (Retirement Plan Investing Essentials, p. 8)

A mutual fund is an open-end investment company, the most familiar type of investment company. Unlike closed-end funds and ETFs, mutual funds do not trade on stock exchanges. Investors buy mutual fund shares from investment companies and sell their shares back to the companies. Traditionally, mutual funds have served as the core investment asset for millions of Americans and, despite new products and technologies, will likely continue to do so for the foreseeable future.

What makes a mutual fund an "open-end" investment company? (Retirement Plan Investing Essentials, p. 8)

A mutual fund is open-end because it constantly issues new shares to investors and stands ready to buy back shares from shareholders.

Do mutual funds with good investment performance tend to continue good performance? Explain. (Retirement Plan Investing Essentials, p. 25)

A number of academic studies have studied the consistency of mutual fund performance, and the results are mixed. Earlier studies tended to find a lack of consistency in fund performance, whereas some recent studies find some persistence in fund performance. Overall, the evidence on consistent fund performance across time is not encouraging. Typically, over a period such as five years, about 75% of mutual fund managers fail to outperform the market.

What is a passive investment management strategy, and what does it seek to accomplish? (Retirement Plan Investing Essentials, p. 126)

A passive investment management strategy means that the investor does not actively seek out trading possibilities in an attempt to outperform the market. Passive strategies simply aim to do as well as the market. Passive investing is concerned with achieving the returns available in various market sectors at minimum costs.

Who is considered a fiduciary under ERISA? (Retirement Plans, p. 511)

A person (or corporation) is considered a fiduciary under ERISA if that person exercises any discretionary authority or control over the management of the plan, exercises any authority or control over assets held under the plan or the disposition of plan assets, renders investment advice for direct or indirect compensation (or has any authority or responsibility to do so), or has any discretionary authority or responsibility in the administration of the plan. Clearly, the trustee of a plan is a fiduciary. So also are officers and directors of a corporation who have responsibility for certain fiduciary functions—for example, the appointment and retention of trustees or investment managers or the appointment and monitoring of an investment advice provider. On the other hand, individuals whose duties are purely ministerial (e.g., applying rules of eligibility and vesting) are not fiduciaries.

Describe the types of issues addressed in a policy regarding hardship withdrawals. (Retirement Plans, p. 535)

A policy regarding hardship distributions should be in place if the plan permits these types of distributions. While the plan document will establish the minimum requirements regarding what qualifies as a hardship, the policy should include the following elements: (a) How frequently are hardship distributions processed (monthly, quarterly or on an ad hoc basis)? (b) Is there a minimum hardship withdrawal loan amount requirement (e.g., $1,000)? (c) What will be acceptable proof to establish the hardship, and/or who will make the determination that there is in fact a hardship? (d) What other sources of funds must a participant have used or attempted to use prior to applying for a hardship distribution?

What is a risk that arises from the very nature of lifecycle funds? (Reading A, An Overview of Lifecycle Funds, Study Guide Module 7, p. 20)

A risk that lifecycle funds pose is associated with the fact that these funds encourage many participants to take a more passive approach in managing their retirement investments. If a lifecycle investor fails to adjust portfolio allocations to reflect changing time horizons or spending needs at any stage of the retirement planning process (accumulation, transition or retirement itself), that investor will incur a risk of not being able to meet spending goals during retirement. The degree of risk will depend on the specific allocation and the desired level of spending. Although the degree of loss in decision making is much less with the static-allocation funds, both types of funds require an educational effort on the part of the plan sponsor to ensure that participants understand the inherent risk of lifecycle funds.

Explain the tax efficiency of index funds. (Retirement Plan Investing Essentials, p. 128)

A significant advantage of index funds is their tax efficiency. Index funds basically buy and hold, selling shares only when necessary. Actively managed funds, on the other hand, do more frequent trading and tend to generate larger tax bills, some of which may be short-term gains taxable at ordinary income tax rates.

As noted in the previous question, most equity funds can be divided into two categories: value and growth. What is the difference between value funds and growth funds? (Retirement Plan Investing Essentials, p. 14)

A value fund generally seeks to find stocks that are inexpensive on the basis of standard, fundamental analysis yardsticks, such as earnings, book value and dividend yield. Growth funds invest in companies that are expected to show strong future growth even if current earnings are poor or nonexistent. (A blend fund is a blend of both growth and value funds.)

Does a variety of investment choices in a well-structured DC plan ensure maximum benefits for participants? Explain. (p. 549)

A variety of investment choices in a well-structured DC plan does not in and of itself ensure that employees will utilize the plan to its full potential. Many plans with ample investment choices underscore the need for educating employees to become better investors. Overall, billions of dollars in DC plan assets are still being invested very conservatively and with little diversification. While this reflects the fact that employees need to know more about investments and financial planning, it also reflects the fact that many employers still have not focused on managing their plans as effectively as possible.

The capital asset pricing model (CAPM) uses standard techniques (simple linear regression) to analyze the relationship between the periodic returns of the portfolio and those of the market (for example, the S&P 500). Explain the importance of the ALPHA value and BETA value produced by the CAPM. -pg446-47

ALPHA value is amount of return produced by the portfolio, on average, independent of the return of market. Alpha is viewed as the level of return contributed because of the skill of the investment manager that is managing the portfolio. BETA is slope of line measured as the change in vertical movement per unit of change in the horizontal movement. This represents the average return on the portfolio per 1% return on the market. If beta is 1.25, then a 2% increase or decrease in market would be expected to be associated with a 2.5% (1.25 X 2) increase (or decrease) in the portfolio, on average.

According to IRS, what conditions must be satisfied in order to perform various functions using electronic media? (Retirement Plans, pp. 510-511)

According to IRS, functions may be performed through the use of electronic media if the following conditions are satisfied: (a) The electronic media must be reasonably accessible to the participant. (b) The electronic form of the notice must be as understandable as the paper version. (c) The participant must be advised that he or she has the right to request and receive the notice or consent forms in paper version at no charge. (d) The system must be reasonably designed to preclude someone other than the appropriate party from giving consent (e.g., by using passwords). (e) The system must give the participant a reasonable opportunity to review, modify or rescind his or her consent before an election becomes effective. (f) The participant must be given confirmation of his or her consent and the terms thereof either through paper or electronic media.

Discuss how equity index funds have performed over time relative to actively managed equity mutual funds. (Retirement Plan Investing Essentials, p. 129)

According to Morningstar, the mutual fund tracking company, for the five-year period ending in 2010, passive equity index funds outperformed active funds within each asset class, except for one, when results were adjusted for survivorship bias. Balanced funds showed the most pronounced level of outperformance while international funds were the lone category where active funds outperformed passive funds. According to S&P, over a recent five-year period, 75% of actively managed mutual funds failed to outperform the market.

What is the rationale for adopting a passive management investment strategy that utilizes index funds? (Retirement Plan Investing Essentials, p. 129)

According to reputable market observers, on average the typical actively managed fund under performs the index by about two percentage points annually. The rationale for this under-performance can be attributed to the following factors: (a) Securities markets are extremely efficient in digesting information. (b) Indexing is cost-efficient, with expenses much lower than actively managed funds. (c) Actively managed funds incur heavy trading expenses. Trading costs can amount to 0.5% to 1.0% per year in additional expenses. (d) Indexing has a tax advantage, deferring the realization of capital gains.

According to the Markowitz model framework, what constitutes an efficient portfolio? (Retirement Plan Investing Essentials, pp. 97-99)

According to the Markowitz model framework, an efficient portfolio is one that has the smallest portfolio risk for a given level of expected return or the largest expected return for a given level of risk.

What distinguishes an age-weighted profit-sharing plan from a traditional profit-sharing plan, and how is such a plan commonly used? (Retirement Plans, p. 391)

Age-weighted profit-sharing plans use a traditional profit-sharing plan structure as their base plan for plan qualification purposes. The distinguishing characteristic of an age-weighted profit-sharing plan is that age factors are used to allocate contributions more heavily to older participants, much like traditional defined benefit plans favor workers with more years of service who are typically older participants. Age-weighted plans tend to appeal to smaller employers with older executive staff and younger rank-and-file employees. Use of an age-weighted profit-sharing plan should be carefully considered. These plans do have certain drawbacks. For instance, two participants with the same years of service and pay levels could receive different annual allocations to their accounts because they fall within different age categories, creating potential for dissatisfaction and misunderstanding among some participants.

How is an investment company compensated if it has no sales charge? (Retirement Plan Investing Essentials, p. 20)

All mutual funds charge shareholders an expense fee to cover operating expenses. The fee is paid out of the fund's income, derived from dividends, interest and capital gains. The annual expense fee consists of management fees, overhead and 12b-1 fees, if any, and are typically stated as a percentage of average net assets, which gives us the expense ratio.

What requirements does ERISA mandate in terms of the writing style of the SPD, and what requirements are imposed if significant numbers of an employer's workforce are literate only in a language other than English? (Retirement Plans, p. 505)

All of the information in the SPD must be "written in a manner calculated to be understood by the average plan participant" and should be "sufficiently accurate and comprehensive" to inform employees and beneficiaries of their rights and obligations under the plan. The explanations provided by legal plan texts and insurance contracts ordinarily do not meet these standards. DOL regulations recommend the use of simple sentences, clarifying examples, clear and liberal cross references, and a table of contents in the SPD. The use of type is important; varying sizes and styles of type may not be used when they may mislead employees. If a plan covers 500 or more people who are literate only in a language other than English, or if 10% or more of the participants working at a "distinct physical place of business" are literate only in a non-English language (25% or more where the plan covers fewer than 100 participants), the SPD must include a prominent notice in the familiar language offering assistance—which may be oral—in understanding the plan.

For a portfolio with only two securities, explain (in words, not numbers) the relationship between the correlation coefficient and the level of portfolio risk. (Retirement Plan Investing Essentials, p. 87)

All other things being equal, the lower the correlation coefficient, the lower the portfolio risk. In other words, risk can be reduced when securities are added to a portfolio, and the risk reduction effect is greatest when the returns have a low correlation. Using Learning Objective 2.5 as an example, in (a), the correlation coefficient is +1, and the portfolio risk is 30%. In (d), the correlation coefficient is lower, and the portfolio risk is 26%. In (b), the coefficient is as low as possible, and the risk is even lower: 5%. (The risk is not eliminated because the standard deviations are not equal.) In (c), the coefficient is zero: There is no relationship between the two securities, and the risk is lower than that calculated in (a) with the perfect positive correlation, but it is higher than that calculated in (b) with the perfect negative correlation. (Portfolio risk cannot be eliminated in this case.)

On what sort of time horizon is it realistic to expect adequate expected return for having assumed the risk associated with various securities? (Retirement Plan Investing Essentials, p. 50)

Although investors may receive their expected returns on risky securities on a long-run average basis, they often fail to do so on a short-run basis. It is a fact of investing life that realized returns often differ from expected returns.

Why do so few individuals use a wealth management context to manage and integrate their retirement plans within their broader family financial planning? (Retirement Plans, pp. 566-567)

Although no single definitive answer to this question exists, there are several reasons that readily can be identified why so few individuals use a wealth management context when managing their retirement plans. First, until rather recently, many aspects of private retirement plans were indeed controlled to a much greater extent by employers. There were few decision factors within an individual's control. For most individuals, the only decision available was the type of annuity to select and whether payments would continue to a spouse upon the individual's death. The opportunity for introducing strategic planning to enhance wealth creation has greatly expanded. Considerably more alternatives and choices are available. There is also much more complexity in today's retirement planning arena. The breadth of choices is relatively new when viewed from a historical perspective. With this empowerment, employees also incur risk when they act to integrate their retirement plans with their other assets and financial strategies. Certain changes in philosophy and the retirement planning paradigm have allowed participants to embark on this more strategic, risk-laden and empowered wealth management activity.

Recognizing that the scope and function of employee benefits administration differ within various organizations, list the core activities that are inherent in employee benefits management generally. (Reading A, Overview of Plan Administration, Study Guide Module 9, p. 21)

Although the scope and function of employee benefits administration differ within various organizations, certain core activities are inherent in benefits management generally. The following activities generally must occur: (a) Benefits plan design (b) Benefits plan delivery (c) Benefits policy formulation (d) Communications (e) Applying technology (f) Cost management and resource controls (g) Management reporting (h) Legal and regulatory compliance (i) Monitoring the external environment.

What factors should be considered in designing a hybrid retirement plan? (Retirement Plans, p. 379)

Among factors that should be considered in designing a hybrid retirement plan are: (a) Workforce demographics and mobility (b) Employee attitudes toward current retirement benefits (c) Relative levels of benefits and rates of benefit accrual (d) Cost constraints for the plan sponsor (e) Certain other items, such as awareness of the legal, regulatory and public relations environment of hybrid plans. These are especially important since plan sponsors have been criticized for the negative effects on benefit accruals or values for certain groups of plan participants upon conversion to a hybrid plan. This criticism of plan sponsors has, at times, resulted in costly litigation.

What is a request for proposal (RFP), and how is it utilized in selecting a plan service provider? (Retirement Plans, pp. 536-537)

An RFP is a formal written document distributed to vendors inviting them to present their capabilities and place a bid with their pricing to become a service provider to the plan. The RFP generally identifies the key items that will be critical to the decision to select one provider over another. Thus, each RFP differs, depending on the particular needs of the organization drafting the RFP.

Distinguish the difference between covariance and the correlation coefficient. (Retirement Plan Investing Essentials, pp. 80-81 and 89-90)

An absolute measure of the degree of association between the returns for a pair of securities is the covariance. A relative measure that shows the extent to which the returns on two securities are related is the correlation coefficient.

Describe the underlying assumption of an active investment management strategy and the most likely form that such a strategy takes. (Retirement Plan Investing Essentials, pp. 130-131)

An active management strategy assumes (implicitly or explicitly) that investors possess some advantage relative to other market participants. The most traditional and popular form of active stock strategies is the selection of individual stocks.

What is an amendment to a plan document, and why do amendments often result in additional plan changes? (Retirement Plans, pp. 532-533)

An amendment to a plan document is a change or modification to the plan document that alters the operation of the plan. Such amendments are often driven by changes in the laws that occur on a continuing basis. Most companies will use the opportunity presented when amendments are needed to comply with new legal requirements, to re-evaluate other features in the plan or to determine whether other amendments should be implemented. Drafting, reviewing, implementing and communicating amendments is a costly process. It not only involves legal costs but also adds the expense of distributing information to plan participants and changing other employee communications such as policy manuals and company websites. Sometimes a plan amendment necessitates changes to payroll systems and company procedures. Often an amendment is communicated through issuance of a summary of material modification (SMM).

Why is an average return for a financial asset useful but insufficient in and of itself when evaluating prospective investment opportunities? (Retirement Plan Investing Essentials, p. 51)

An average return for a financial asset is useful but insufficient in and of itself when evaluating prospective investment opportunities. This is the case because the average return, however measured, though an extremely important piece of information for the investor, only tells the center of the return distribution. In essence, the average return does not tell an investor anything about the spread of the distribution.

Explain the concept of an efficient market. (Retirement Plan Investing Essentials, p. 146)

An efficient market is one in which the prices of all securities quickly and fully reflect all available information about the assets. The current stock price reflects all known information and all information that can be reasonably inferred. A market is efficient relative to any information set if investors are unable to earn abnormal profits (returns beyond those warranted by the amount of risk assumed) by using that information set in their investing decisions.

Explain the contribution to the theory of behavioral finance by DeBondt and Thaler known as the overreaction hypothesis. (Retirement Plan Investing Essentials, p. 165)

An important step in the development of behavioral finance is the work of DeBondt and Thaler. These researchers tested an overreaction hypothesis, which states that people overreact to unexpected and dramatic news events. As applied to stock prices, the hypothesis states that, as a result of overreactions, "loser" portfolios outperform the market after their formation. The researchers interpreted this evidence as indicative of irrational behavior by investors, or overreaction. Investors overreact to information about companies and drive stock prices to unsustainable highs or lows. When investors realize later that they overreacted to the news, prices return to their correct levels.

What is an index fund? (Retirement Plan Investing Essentials, p. 127)

An index fund is a pool of assets designed to duplicate as nearly as possible the performance of some market index. A stock index fund may consist of all the stocks in a well-known market average such as Standard & Poor's 500 Composite Stock Index (S&P 500).

Discuss the merits of combining various types of distribution options as components of a retirement income strategy. (Retirement Plans, p. 594)

An individual may opt to combine various distribution options as part of a retirement income strategy. If an individual possesses sufficient resources and has charitable giving or estate-planning objectives in addition to retirement income objectives, it is even more likely that a single distribution option will fail to meet all of the individual's needs. Therefore, many individuals evaluate multiple distribution forms as components of their overall retirement income strategy. In addition to blending multiple income distribution forms, the timing when these distributions commence also can be varied. As such, a phased approach can produce income enhancements at select prearranged times or when circumstances dictate additional resource needs.

Provide the definition of an investment advisor as contained in the Investment Advisers Act (Advisers Act), detailing its three main elements and six exclusions. (Reading A, How Are the Fiduciary Duties under the DOL's New Fiduciary Advice Rule Different from the Securities Laws?, Study Guide Module 11, pp. 30-31)

An investment advisor is any person who, for compensation, engages in the business of advising others, either directly or through publications or writings, as to the value of securities or as to the advisability of investing in, purchasing or selling securities or who, for compensation and as part of a regular business, issues or promulgates analyses or reports concerning securities. Unless one of six exclusions applies, a person is considered an investment advisor under the Advisers Act if each of the following three elements is met: (a) The person provides advice or issues reports or analyses to others concerning securities. (b) The person is in the business of providing those services. (c) The person provides those services for compensation. The Advisers Act generally excludes the following six categories: (a) Banks, bank holding companies and savings associations (b) Lawyers, accountants, engineers and teachers (c) Certain brokers and dealers (d) Publishers of bona fide publications of general and regular circulation (e) Government securities advisers (f) Nationally recognized statistical rating organizations (NRSROs) (g) Other persons excluded by the SEC pursuant to statutory authority. The limited exemption for broker-dealers is particularly significant because many courts have held that brokers are not subject to fiduciary duties unless they have investment discretion over an account.)

What can be said about the quality of analysts' earnings per share forecasting? (Retirement Plan Investing Essentials, pp. 133)

Analysts spend much of their time forecasting earnings. Regardless of the effort expended by analysts, investors should be cautious in accepting analysts' forecasts of earnings per share (EPS). The forecasts for long-term EPS are typically overly optimistic. Errors can be large and occur often.

Describe the basic objectives behind the use of dedication and immunization techniques for pension plan portfolios. (Retirement Plans, p. 455)

Another form of passive investment of pension plan assets makes use of the bond market and has been variously referred to as dedication, immunization and contingent immunization. This technique attempts to construct a bond portfolio such that its cash flow can be used to fund specific plan liabilities, such as to pay benefits to a group of retirees.

What are a plan sponsor's responsibilities in responding to a claim for benefits under a plan if the claim is a denial of benefits? (Retirement Plans, p. 508)

Anyone denied a claim under any plan is entitled to a written statement giving the reasons for the denial, usually within 90 days. This explanation should be a clear, comprehensible statement of the specific reasons for the denial of the claim. The explanation also must include a description of any material or information necessary for the claimant to improve the claim and the reasons this additional material is needed. Also in the explanation there should be a full description of the plan's appeal procedure. The claimant must be given at least 60 days thereafter in which to appeal the claim and is entitled to a final decision in writing within 60 days of the appeal (120 days in special circumstances).

Explain the penalties, in addition to the excise taxes imposed because of a prohibited transaction under the tax law, that are applicable to a fiduciary for breach of duties. (Retirement Plans, p. 513)

Apart from excise taxes that might be imposed because of a prohibited transaction under the tax law, a fiduciary will be personally liable for any breach or violation of responsibilities and will be liable to restore any profits made through the use of plan assets. In addition, the Department of Labor (DOL) may impose a 20% penalty on any fiduciary who is found liable for a breach of fiduciary rules. The penalty is applied to the recovery amount—that is, the amount recovered from the fiduciary on behalf of the plan or its participants pursuant to either an out-of-court settlement with DOL or a court order under a judicial proceeding instituted by DOL. DOL may waive or reduce the penalty in cases where the fiduciary acted reasonably and in good faith or where the fiduciary will not be able to restore all losses to the plan absent the waiver or reduction. The penalty is automatically reduced for prohibited transactions by the 15% excise tax imposed in those cases.

Define what is meant by hyperbolic discounting and how it contributes to participant inactivity in planning for retirement. (Retirement Plans, p. 191)

Apart from sheer loss aversion that results from forgoing current consumption, individuals tend to overemphasize immediate desires and rewards at the expense of their longer term needs. Not surprisingly, present needs consistently appear more pressing. Hyperbolic discounting is the human tendency, when faced with uncertainty, to sharply reduce the importance of the future in the decision-making process. Consequences that occur at a later time, good or bad, tend to have a lot less bearing on choices. Survey results have shown that 25% of workers who have access to a defined contribution plan fail to contribute at all, while fewer than 10% will contribute at the maximum level allowed under the law. Furthermore, consumption levels tend to progress upward as income levels increase. Individuals have a proclivity to spend more as they earn more.

What is tactical asset allocation and how does it differ from strategic asset allocation? (Reading B, Evaluating and implementing target-date portfolios, Study Guide Module 7, p. 35)

As noted in Learning Objective 2.2, tactical asset allocation is a type of dynamic asset allocation that actively and systematically adjusts the strategic portfolio mix of an entire TDF allocation based on relative short- to intermediate-term market conditions. Such an approach attempts to add value beyond that of a baseline strategic asset allocation by altering systematic risk factors and overweighting asset classes that are expected to outperform on a relative risk-adjusted basis in the near term. By contrast, strategic asset allocation involves establishing long-term target allocations to major asset classes based on financial goals, risk tolerance, time horizon and other considerations. Although this approach is designed to be mostly stable over the short term, alterations to an asset mix may occur over the long term. Studies show that, on average, tactical asset allocation strategies have not produced excess returns over all time periods and, on average, have tended to increase cost without achieving higher average returns.

As researchers have studied decision making in the newly emerging field of behavioral finance, what are certain key themes that have been found within these studies? (Retirement Plans pp. 188-189)

As researchers have studied decision making within the newly emerging field of behavioral finance, certain key themes have emerged. Among these key themes are the following: (a) Heuristics: People often make decisions based on approximate, so-called rules of thumb that are not entirely grounded in strictly rational analyses. Shortcuts to decision making can result from difficulty in assembling all of the relevant information or from limitations on the decision maker's capabilities or competencies. Therefore, decisions often fall short of the optimal positive determinations suggested by neoclassical economists. (b) Framing: The way a problem or decision is presented will affect an individual's action. The outcome then is sometimes less than optimal. Importantly, decision makers are influenced by the depiction of the choice, and their decisions appear to be susceptible to manipulation. This theme has both negative and positive implications. On the negative side, it suggests that economic agents' decisions can be flawed and are far less reliable and logical than previously envisioned. On the positive side, however, is the potential promise that decisions framed differently can guide decision makers to make more optimal choices. (c) Market inefficiencies: Market outcomes diverge from what would be expected if market efficiency was present. Real-life outcomes that previously appeared unexplainable by economic modeling are seen as explainable once social, cognitive and emotional biases are recognized. No longer must observable conditions in the real world be deemed unexplainable or mysteriously incongruent with logical economic modeling. The introduction of a more accurate portrayal of human economic agents explains market conditions.

Describe how the number of securities held in a portfolio determines how each individual security's risk or covariance impacts the overall risk associated with the portfolio generally. (Retirement Plan Investing Essentials, p. 88)

As the number of securities held in a portfolio increases, the importance of each individual security's risk (variance) decreases, and the importance of the covariance relationship increases.

Before an individual begins to save within a retirement savings vehicle, how does he or she assess the compatibility of a savings structure with his or her needs? (Retirement Plans, p. 574)

Before beginning to save within a retirement savings vehicle, an individual should assess the compatibility of the savings structure with his or her needs. All of the economic and administrative characteristics of a given structure can ultimately affect the capacity of the assets held within the structure to accumulate wealth. Particular needs of the account owner can trigger transactions that can incur additional costs or subject the investments to regular taxation or additional penalty taxes. Therefore, the utmost care should be taken in assessing whether a given structure is the appropriate selection for an individual's personal circumstances. Circumstances in the broader environment should be assessed as well.

Describe the DOL regulations around fee disclosure for plan sponsors/fiduciaries and plan participants. (Retirement Plans, p. 507)

Beginning in 2012, covered service providers and plan fiduciaries need to disclose retirement plan fees so that plan participants can more easily understand the costs related to plan investments that they select under their retirement plan options. There are two sets of regulations related to fees. The first regulations require those providing services to pension, profit-sharing, 401(k) and 403(b) plans subject to ERISA to disclose in a written form the services they provide and the total compensation they receive either directly from the plan/plan sponsor or indirectly from a source other than the plan/plan sponsor. The second regulations are those that mandate disclosure from plan sponsors to plan participants or beneficiaries. The two categories of information that plan sponsors must provide are: (1) Plan-related information, including general plan information, administrative expense information and individual expense information (2) Investment-related information, including performance data, benchmarking information, fee and expense information, Internet access to investment-related information and a glossary to assist participants with investment-related terminology.

Enumerate the propositions on which the behavioral finance view of markets and market efficiency is based. (Retirement Plan Investing Essentials, pp. 164-165)

Behavioral finance analyzes behavioral biases and the effects these biases have on financial markets. The behavioral finance view of markets and market efficiency is based on the following propositions: (a) Informed traders face risk-aversion constraints in seeking to keep prices efficient. The efficient market hypothesis (EMH) argues that well-informed, risk-tolerant investors keep prices at their "fair values." When prices are sufficiently out of line to warrant action by investors, they act to move them back. However, there are limits to arbitrage, which may constrain price adjustments. (b) The trading decisions of individual investors are biased because of biases associated with human behavior. (A detailed explanation of several of these research-identified biases is provided in Learning Objectives 3 and 4 of this module.) (c) The purchases and sales of individual investors are highly correlated. In other words, individual investors tend to buy and sell the same stocks at the same time. This herding effect by individual investors can push the prices of stocks in one direction in a significant manner. (d) Individual investors, who are considered the uninformed investors, generate buy/sell imbalances that drive prices away from fundamental value. (e) Over time, informed investors will drive prices back to fundamental value.

(a) How do benefit portability and the availability of lump sums in a retirement plan tend to be advantageous to an employer offering these plan features, and (b) what disadvantages can arise with these same plan features? (Retirement Plans, p. 385)

Benefit portability and the availability of lump-sum distributions are key features offered by many defined benefit hybrid retirement plans. These plan features usually are perceived as being advantageous to the employee. There are also several advantages that an employer receives by offering these plan features. At times, however, there are certain disadvantages to the employer that accompany these plan features. (a) Since benefit portability and the availability of lump-sum distributions typically result in employees seeing greater value in a retirement plan, such features may provide advantages to an employer in recruiting and retaining human resources. Specifically, the following direct advantages may result: • It may be easier to attract and retain younger and more mobile employees who would not normally expect to receive a significant benefit from traditional defined benefit plans. • Midcareer employees who are only remaining with the employer because of pension benefits can take their account balances and move their careers in a new direction. Companies find this to be beneficial since employees who are unhappy are able to leave and be replaced by more highly motivated employees. (b) There are certain disadvantages that can accompany benefit portability and lump-sum distributions. Specifically, the following disadvantages may result: • Portable account balances may make it too easy for employees to leave for other employment too quickly. • If benefits do not accrue quickly enough, younger and more mobile participants may not perceive sufficient value in the retirement plan. • If the overriding purpose of the plan is to provide retirement benefits, then the option to take a lump-sum distribution upon retirement or termination of employment may defeat the plan's primary purpose.

What is the definition of beta as conceptualized in the CAPM? (Retirement Plan Investing Essentials, p. 175)

Beta is a relative measure of risk—the risk of an individual stock relative to the market portfolio of all stocks. Thus, beta is a measure of the systematic risk of a security that cannot be avoided through diversification.

Describe the respective roles of employers and employees in the plan investment provisions of a (DC) plan. (Retirement Plans, pp. 547-548)

Both employers and employees have a vital stake in the plan investment provisions of a DC plan. The employer is responsible for: (a) Structuring appropriate investment programs (b) Selecting suitable investment managers (c) Monitoring investment performance (d) Communicating critical investment provisions to employees. In the typical plan, employees are responsible for deciding how to invest their account balances. It is important to note that employees assume all of the risks associated with investment performance. Both employers and employees must have a sound understanding of basic investment principles if they are to succeed in fulfilling their respective responsibilities.

What elements of nondiscrimination testing are made more complicated when a plan sponsor offers an age-weighted profit-sharing plan or new comparability plan? (Retirement Plans, pp. 391-392)

Certain elements of nondiscrimination testing are made more complicated when a plan sponsor offers an age-weighted profit-sharing plan or new comparability plan. Both age-weighted and new comparability plans must satisfy the requirements of IRC Section 401(a)(4) that benefits not discriminate in favor of highly compensated employees. These types of plans satisfy the nondiscrimination requirements using a process called cross-testing. Cross-testing is sometimes referred to as benefits testing because nondiscrimination is tested on the basis of projected benefits rather than on the basis of current contributions. Cross-testing makes it possible to allocate more to highly compensated and older participants because when compound interest assumptions are used to project benefits, lesser amounts of annual contribution are needed to provide younger and lower paid participants with a projected benefit that is a substantial percentage of pay.

Explain the circumstances under which preference for the prevailing condition because of status quo bias is irrational. (Retirement Plans, p. 191)

Closely related to procrastination, and perhaps overlapping with procrastination and inertia, is status quo bias. When comparing actively making decisions or taking a positive step or decisive move, individuals have a proclivity to prefer the status quo, or the prevailing condition. As cited in the previous example, status quo bias is not irrational when the decision is cost-neutral or when uncertainty is so pronounced that the likelihood of a gainful outcome is highly suspect or unsure. However, an ensured receipt of an employer matching contribution within a 401(k) plan is neither a cost-neutral situation nor an uncertain outcome. Quite the contrary: It is a delayed decision carrying a very high cost, especially when the effects of compounding are considered. However, the compounding effect is probably masked due to hyperbolic discounting.

Does conformity with the Section 404(c) safe harbor provisions relieve an employer of fiduciary responsibility for plan investments? (Retirement Plans, pp. 550-551)

Compliance with the Section 404(c) safe harbor provisions does not relieve the employer of the responsibility of ensuring that the investment options offered under the plan are prudent and properly diversified and does not relieve the employer of fiduciary responsibility for investments over which the employee has no control, such as employer contributions that are automatically directed to one of the investment options. As noted in Learning Objective 5.5, PPA allows (does not mandate) plan sponsors to offer investment advice services. If plan sponsors do offer such services to their participants, they assume certain fiduciary responsibilities. They must prudently select the advice provider and must monitor the services provided. Therefore, fiduciary responsibilities relate both to the appointment of the investment advice provider and the ongoing monitoring process of the investment advice provider. The Department of Labor (DOL) has specified the criteria that should be followed when appointing an investment advice provider and prescribed plan sponsors' responsibilities for monitoring the advice provided.

What is contrarian investing? (Retirement Plan Investing Essentials, pp. 165-166)

Contrarian investing is the belief or investment theory that holds it is profitable to trade contrary to most investors. This investment approach involves taking positions that are currently out of favor. The investing philosophy particularly espouses the investor overreaction hypothesis, which states that investors overreact to events in a predictable manner, overvaluing the best alternatives and undervaluing the worst. Those who practice the contrarian investing approach tend to favor low price/ earnings (P/E) ratio stocks, which are often out of favor, rather than the often popular high P/E ratio stocks.

Beyond the "core," or baseline, prudent best practices contained in Section 404 of ERISA, has DOL ever opined further on investment duties of trustees regarding "enhanced" ERISA prudent best practices for innovative investments, and how would a fiduciary indicate that such investments are "solely in the interest of the participants and beneficiaries"? (Reading B, Prudent Management of Innovative Investments in ERISA Plans, Study Guide Module 10, pp. 31-32)

DOL has intermittently published additional supplemental ERISA prudent practices for innovative investments. Such documents have covered such issues as derivative investing in pension plans, a prudent investment process and the consideration of economically targeted investments. Additionally, some DOL publications provide guidance on prudent investing generally that can be applied to innovative investments. When considering the inclusion of innovative investments within an ERISA-qualified plan, a fiduciary should note ERISA's general obligation to engage in a procedurally and substantively prudent process when selecting new investments. As part of this process, fiduciaries must analyze the needs and goals of the plan and its participants and evaluate the appropriateness of an investment in light of those particular needs and goals. A detailed checklist should be developed to cover all known conflicts of interest, and documentation should be maintained to illustrate that the decision was made solely in the interest of the participants. In its publication about selecting TDFs, DOL goes to great lengths to consider individualized strategies that could better fit the needs of a particular subset of participants.

Within what time period must plan sponsors remit participant contributions after withholding these monies from employee paychecks? (Retirement Plans, p. 517)

DOL has taken the position that participant contributions become plan assets as of the date they can be segregated from the employer's general assets but no later than 90 days after withholding. However, DOL issued final regulations in August 1996 that shorten this outside deadline to the 15th business day following the month in which the employee contribution is received or withheld. A procedure is set forth under which an employer can obtain an additional ten business days if certain conditions are met.

Describe the four types of investment-related information that employers can provide to employees without fear of exposing themselves to fiduciary liability in the view of DOL. (Retirement Plans, p. 516)

DOL issued an interpretive bulletin to enable employers and providers to distinguish between education and advice. The bulletin specifies four types of investment-related information that employers could provide without fear of exposing themselves to fiduciary liability in the view of DOL. These safe harbors are: (1) General plan provisions. These include information about plan features and operations, the benefits of participating in the plan, and descriptions of the plan's investment alternatives, including investment objectives, risk-and-return characteristics and historical information—as long as such information does not address the appropriateness of particular investment options for a given participant or beneficiary. (2) General financial and investment information. Information about general investment concepts may be provided—for example, risk and return, diversification, dollar-cost averaging and the advantages of tax-favored savings. It also is acceptable to provide information as to historical differences in rates of return among different asset classifications, investment time horizons and estimates of future retirement income needs. (3) Asset allocation models. Participants and beneficiaries can be provided with asset allocation models illustrating the projected performance of hypothetical asset allocations using varying time horizons and risk profiles. (4) Interactive investment material. Acceptable material includes items such as questionnaires, worksheets, computer software and other materials that employees can use to estimate their retirement income needs and the potential impact of various investment strategies on their ability to meet those needs. To qualify for safe harbor treatment, asset allocation models and interactive materials must be based on generally accepted investment theories, and their underlying assumptions must be disclosed (or, in the case of interactive materials, selected by the participant). And, if allocation models or interactive materials identify a specific investment option under the plan, they should indicate that other investment alternatives having similar risk-and-return characteristics may be available under the plan and must identify where information on these alternatives may be obtained. Further, models and interactive materials must be accompanied by a statement explaining that participants should consider all of their other income, assets and investments in applying the model or using the interactive tool.

Describe the high level of complexity implicitly contained with decisions when planning for retirement. (Retirement Plans, p. 192)

Decisions about selecting investments and planning for retirement involve a high level of complexity and are not easy for individuals to solve. When individuals attempt to save, invest and plan for retirement, they need to make decisions under uncertainty. These decisions involve weighing a number of competing factors, assigning priorities to these factors, projecting certain trends and expectations into the future, and performing complicated computations to which individuals cannot easily intuitively assign values. In short, even if a person desires to plan for retirement, reducing the problem to a manageable basis is not an easy exercise. In fact, many individuals find the nature of the decision to entail such complication that they need significant professional assistance to design their personal plan if they are to plan effectively.

Describe important considerations in developing a retirement income strategy. (Retirement Plans, p. 593)

Developing a retirement income strategy involves several important considerations. First, an individual must assess retirement income needs and have some idea of the ongoing expenses he or she will incur during retirement. Additionally, an individual should assess his or her risks and the possibility of additional expenses related to the occurrence of these risks. Costs and tax implications of various approaches should be considered. Apart from the tax consequences, individuals make decisions regarding which income-generating options will supply the resources needed to provide income sufficiency for an extended period of time. For the participant who possesses both a defined benefit (DB) and a defined contribution (DC) plan, the income options selected under the DC plan should be made, supplementing the stream of income that will be generated from the DB plan. Similarly, the income stream generated by Social Security, which is almost universally available to workers, should also be considered when deciding on the form and level of resources distributed from the DC plan. Comparisons should be made between the budgeted resource needs of the individual and the extent to which distributions from guaranteed sources will meet the minimum income needs in retirement. For those possessing DC assets only, it is critical that the decision to convert assets into income be well-conceived, considering risks inherent in the capital markets.

Explain how consumer protections regarding investment advice were crafted under the prior regulatory regime and what changes were made by the Fiduciary Advice Rule. (Reading A, How Are the Fiduciary Duties under the DOL's New Fiduciary Advice Rule Different from the Securities Laws?, Study Guide Module 11, pp. 26-27)

ERISA and the Internal Revenue Code (IRC) establish consumer protections for some investment advice that does not fall within the ambit of federal securities laws and vice versa. Both ERISA and IRC define a fiduciary to include those who render "investment advice" for a fee or other compensation, direct or indirect, with respect to any monies or other property of such plan or those who have any authority or responsibility to do so. However, the original regulation defined qualifying investment advice in a restrictive way that required, among other things, that the advice be provided on a regular basis and pursuant to an understanding that the advice would be a "primary" basis for the plan's investment decisions. Thus, advice provided on a single occasion (e.g., advice concerning plan rollovers) would not qualify, and most contracts with benefit plan investors simply contained a provision that the advice was not being provided as a primary basis for investment decisions. This made it relatively easy to avoid fiduciary status for advice providers. Now, though, the Fiduciary Advice Rule substantially expands the definition of investment advice in this context, with vast implications. Investment advice is defined as a recommendation to a plan, plan fiduciary, plan participant, plan beneficiary or an individual retirement account (IRA) owner for a fee or other compensation, direct or indirect, as to the advisability of buying, holding, selling or exchanging securities or other property or as a recommendation as to how securities or other investment property should be invested after a rollover. Covered investment advice also includes recommendations as to the management of securities or other investment property, including recommendations on investment policies or strategies, portfolio composition, selection of other persons to provide investment advice or management services, or selection of investment account or as recommendations with respect to rollovers, transfers or distributions, including recommendations as to the amount, form and destination of such rollover, transfer or distribution. The key to determining the existence of fiduciary investment advice is whether a recommendation occurred. A recommendation is defined as a communication that, based on its content, context and presentation, would reasonably be viewed as a suggestion that the advice recipient engage in or refrain from taking a particular course of action. The more individually tailored the communication is to a specific advice recipient or recipients, the more likely the communication will be viewed as a recommendation.

Summarize the five distinct categories of duties imposed upon fiduciaries by ERISA, as well as its additional stipulation concerning co-fiduciary duties. (Reading A, How Are the Fiduciary Duties under the DOL's New Fiduciary Advice Rule Different from the Securities Laws?, Study Guide Module 11, p. 29)

ERISA imposes five distinct duties on fiduciaries. These duties are as follows: (1) ERISA fiduciaries have a duty of loyalty. (2) ERISA fiduciaries have a duty of prudence. (3) ERISA fiduciaries have a duty to diversify investments. (4) ERISA fiduciaries have a duty to follow the plan documents. (5) ERISA fiduciaries have a duty to monitor. In addition to the previously stated five distinct duties, ERISA also imposes co-fiduciary duties. Under ERISA, a fiduciary can be liable for the actions of another fiduciary if the first fiduciary: (a) Knowingly participates in or conceals the second fiduciary's breach of fiduciary duties (b) Fails to abide by the fiduciary duties and thereby enables the second fiduciary to breach the fiduciary duties or (c) Has knowledge of a fiduciary breach and fails to act to remedy the breach.

In order to qualify for statutory relief from fiduciary liability, what must a plan sponsor supply to a plan participant regarding investment alternatives? (Retirement Plans, p. 515)

Each participant must be provided with or have the opportunity to obtain sufficient information to make informed decisions as to investment alternatives under the plan, as well as financial information concerning these alternatives. This includes, among other things: (a) A general description of the investment objectives and risk-and-return characteristics of each investment alternative (b) An explanation of how to give investment instructions and any limitations on such instructions (c) An identification of investment managers (d) An explanation of voting, tender and similar rights (e) A description of transaction fees and expenses that could affect the participant's account balance (f) The name, address and phone number of the plan fiduciary (g) Where appropriate for the investment alternative, any applicable prospectus (h) A notice that the plan is intended to comply with ERISA Section 404(c) and that fiduciaries' liability is thereby limited (i) If a plan utilizes automatic enrollment and default investment alternatives, these must be specified as described in Module 6.

Describe 4 steps involved in effective performance measurement and four important caveats to keep in mind when choosing a performance measurement system. -pg444

Effective performance measurement: Definition-investment objectives, clearly formulated portfolio strategy Input-availability of reliable and timely data Processing- Use of appropriate statistical methods to produce relevant measurements. Complex interaction of objectives, strategies, and managers tactics, cannot be understood if inappropriate statistical methods are used Output-Analysis of process and results presented in a useful format. Presentation should relate realized performance to objectives and pre-established standards. 4 caveats: Danger that hastily chosen system poorly related to real needs can rapidly degenerate into a mechanistic, pointless exercise. System should fit the investment objectives-not the reverse. Measuring the process may alter it. To save time and cost, it is important that over-measurement be avoided.

If a plan sponsor wants to use electronic media to fulfill its reporting and disclosure requirements, what conditions must be met? (Retirement Plans, pp. 509-510)

Electronic delivery may be used if the employee has access to the employer's computer system where the employee is reasonably expected to perform his or her duties. Access to the computer system must be an integral part of the employee's duties. Providing access to electronic documents using a computer kiosk in a common area would not meet this requirement. Use of electronic media is permitted for disclosure to non-employees as long as these individuals provide an address for electronic delivery of documents and affirmatively consent to the electronic disclosure in a manner that reasonably demonstrates the individual's ability to access information in electronic form. Non-employees must give this consent after receiving a statement from the plan sponsor explaining the electronic delivery system and the hardware and software needed to use it. Additionally, all of the following conditions must be met: (a) The administrator must take appropriate and necessary measures to ensure that the system for furnishing the document results in actual receipt by participants of the transmitted information and documents. (b) Each participant must be provided with notice, through electronic means or in writing, apprising the participant of the document to be furnished electronically, the significance of the document and the participant's right to request and receive a paper copy of the document. (c) On request, the plan administrator must provide the document in paper form to a participant. (d) The electronically furnished version of the document must be the same in all material respects as the paper version. (e) The electronically furnished document must satisfy all other requirements with respect to the substance and presentation required to be in the paper version of such a document. (f) When a disclosure includes personal information relating to an individual's accounts or benefits, the plan administrator must take reasonable and appropriate steps to safeguard the confidentiality of the information.

What is an enhanced index fund? (Retirement Plan Investing Essentials, pp. 128-129)

Enhanced index funds are index funds that are tweaked by their managers to be a little different. For example, an enhanced fund tracking the Standard & Poor's (S&P) 500 could have the same industry sector weightings as the S&P 500 but hold somewhat different stocks, perhaps with lower price/earnings (P/E) ratios. Or an enhanced fund can use futures and options to hold the S&P 500 and invest the remainder of the funds in bonds or other securities. The theory is that the manager can, by tweaking the fund slightly, outperform the index.

Are there limits on an individual's ability or likelihood of making the most optimal choice when it comes to planning for retirement? (Retirement Plans, p. 192)

Even if individuals do not succumb to choice overload, the odds against making optimal choices are formidable, a condition known as bounded rationality. Individuals have limitations regarding their mental capabilities to deal with complexity inherent in retirement planning. The historical portrayal of economic agents assumed capabilities exceeding the skill set of many individuals.

Given the controversy involving market efficiency and research findings from behavioral finance, what choice is left to investors? (Retirement Plan Investing Essentials, p. 168)

Every investor is faced with the choice between pursuing an active investment strategy, a passive investment strategy or some combination thereof. (The preceding module in this course provided detailed information on both of these investing strategies.) Making the choice depends heavily upon what the investor believes about efficient markets. However, investors who plan, or wish, to pursue some type of active strategy should consider a quote attributed to Warren Buffett: "Most investors, both institutional and individual, will find that the best way to own common stocks (shares) is through an index fund that charges minimal fees. Those following this path are sure to beat the net results (after fees and expenses) of the great majority of investment professionals."

Most TDFs are funds of funds, and plan sponsors must decide whether the underlying funds are to be all active management, all indexed (passive) management or a combination of the two. What are the factors to consider when assessing a passive management strategy? (Reading B, Evaluating and implementing target-date portfolios, Study Guide Module 7, pp. 30-31)

Factors to consider when assessing a passive management strategy include the ease with which performance results can be communicated to participants, the inherent lower costs of this strategy and the implications for fiduciary oversight. Index funds provide returns that are close to those of asset-class performance benchmarks. This is an especially important factor since most TDFs are designed based on expected asset-class returns, and index funds can virtually ensure that those asset-class returns are generated for investors. Index funds also provide return patterns that are potentially easier to explain to the participant population. Of course, it is possible for the active manager to outperform the market, generally leaving little need for explaining. A big reason for the advantage of index funds is cost. Cost can be a significant determinant of active management's long-term success relative to an index. The longer the time period—and TDF investing can span up to 40 years—the more important the role of costs. From a fiduciary perspective, and with a default investment fund in mind, an index approach may have advantages over an active approach. Fiduciaries that venture from the relative safety of indexed funds to actively managed funds assume greater risk of their choices being judged imprudent in the event of poor returns.

Discuss the applicability of other requirements that emerge once an advisor is deemed to have fiduciary status. (Reading A, How Are the Fiduciary Duties under the DOL's New Fiduciary Advice Rule Different from the Securities Laws?, Study Guide Module 11, p. 33)

Fiduciary status carries with it other requirements and risks beyond just compliance with the fiduciary requirements. Some of these requirements can be summarized as follows: (a) Fiduciaries face additional challenges complying with prohibited transaction rules. There is a broad statutory exemption for service providers, but DOL has taken the position that this exemption does not apply to transactions in which fiduciaries operate under a conflict of interest. This makes finding a prohibited transaction exemption more difficult for fiduciaries and may leave many with no option other than compliance with the BIC Exemption, despite the added litigation risk. (b) Fiduciaries are required to obtain a bond covering acts of theft and dishonesty. (c) Fiduciary status may create potential liability not covered under some advisors' existing insurance program. As a result, advisors may need to acquire fiduciary liability insurance. (d) The fee-disclosure rules will also be an issue for those who wish to maintain the service provider exemption as an option.

Describe the three types of models (and their inherent limitations) used by financial advisors to target retirement resource needs. (Retirement Plans, pp. 570-571)

Financial advisors attempt to target retirement resource needs using various types of models. These models may be helpful but have limitations. Retirement planning software models may be segmented into the following three model types. (a) Deterministic models use a set of "fixed" assumptions. The assumptions are determined by the model developer, the model user or some combination of the two. Purely deterministic models do not possess effective means for measuring risk. They can illustrate risks in two ways: (a) The model can be run multiple times illustrating different scenarios, or (b) assumptions can be varied indicating sensitivity to various assumptions (i.e., investment return, mortality, inflation, etc.). An example of a deterministic model would be one that projects asset accumulations based on current holdings and an assumed savings rate, given assumptions about investment return and salary increases. This type of model provides a single, expected, future asset accumulation based on the inputs of beginning balance, years to retirement, investment return, ongoing savings amount and salary increases. (b) Stochastic models do not use fixed assumptions but rather vary assumptions and yield probabilities of success or failure depending on repeated iterations of the model. These models employ statistical techniques to introduce variability into the parameters of the model. Pure stochastic models do not really exist because all of these models need to employ certain fixed assumptions. Although the models allow for the variation of some assumptions, there are some elements that remain fixed, even though these elements of the environment actually can and do undergo change. (c) Mixed models use a combination of fixed (deterministic) assumptions and variable assumptions. These models allow a certain set of assumptions to vary; thus, these types of models attempt to gauge probabilities of success or failure. Monte Carlo techniques are examples of these mixed models. A simulation is an analytical method meant to imitate a real-life system, especially systems that are too mathematically complex or too difficult to reproduce. A Monte Carlo simulation selects variable values randomly, and the model is run multiple times to assess outcomes. For each uncertain variable that can have a range of possible values, the possible values are defined with a probability distribution. The type of distribution selected is based on the conditions that surround this variable.

In contrast to a defined benefit plan, why are the fees charged to a defined contribution plan a fiduciary issue? (Retirement Plans, p. 538)

For defined benefit plans, the impact of any fees is borne by the plan sponsor, since they are either paid directly by the plan sponsor from assets outside the plan or paid from plan assets. If paid from plan assets, this effectively results in increased contribution requirements for the plan sponsor since participant benefits are determined by the plan's formula. However, for defined contribution plans, if the fees are paid from plan assets, the net effect is to reduce participant benefits. Therefore, the actual structure of the fees for defined contribution plans becomes a fiduciary issue. In short, plan fees have a detrimental impact on participant and beneficiary benefits in a defined contribution plan.

Explain the reasons pension plans often choose mutual funds as investment vehicles. (Retirement Plans, p. 451)

For plans with assets too small to be handled by an investment manager, mutual funds may be the only choice other than a common trust fund. Larger plans also may choose mutual funds as a relatively inexpensive way of diversifying their portfolios. Pension plans choose to invest in mutual funds for the following reasons: (a) Greater liquidity via ease of entry and exit (b) Greater degree of diversification (c) Easier means of portfolio specialization (d) Daily update of holdings via Internet listings (e) Easy to meet asset alloc./market timing goals (f) Ease of checking past performance through published studies and indexes.

Must an innovative investment strategy be well-diversified? (Reading B, Prudent Management of Innovative Investments in ERISA Plans, Study Guide Module 10, p. 34)

Generally the answer to this question would be yes. It would be hard to justify why a prudent fiduciary would not want a diversified portfolio when ERISA is clear that this is generally a requirement unless it is clearly prudent not to have one. MPT constructs a risk-and-reward frontier that assumes diversification always eliminates nonsystematic risk. Since MPT is a bedrock principle of ERISA, diversification is very important. Consideration must be given to how participants would handle the innovative investment in a participant-directed plan. In other words, might it be possible for a participant to only invest in the strategy when it was intended to be part of a larger diversified portfolio? Participant behavior should be taken into account when the innovative investment is added to the fund line.

What are hedge funds? (Retirement Plan Investing Essentials, pp. 28-29)

Hedge funds are unregulated investment companies that seek to exploit various market opportunities to earn larger-than-ordinary returns for their investors. They require a substantial initial investment and may have restrictions on timing of withdrawals. Hedge funds may use leverage or derivative securities, or they may invest in illiquid assets, strategies not generally available to the typical mutual fund. Hedge funds traditionally do not disclose information to their investors about their investing activities. Also, the funds charge substantial fees and typically take at least 20% of the profits earned.

Although PPA did not change the requirement to supply a benefit statement upon request to a plan participant within any 12-month period, how did it expand the need to supply such statements and with what frequency for various types of retirement plans? (Retirement Plans, p. 502)

Historically a plan sponsor was required to supply a benefit statement to a participant or beneficiary upon request, although the employer was not required to provide more than one statement in every 12-month period. PPA modified the requirements for benefit statements, expanding the need for issuance beyond the need to fulfill a plan member's request in any 12-month period beginning after December 31, 2006. Under PPA rules: (a) If a participant in a defined contribution plan is entitled to direct plan investments, he or she must receive a benefit statement once per quarter. (b) If a participant in a defined contribution plan is not entitled to direct plan investments, he or she must receive a benefit statement once per year. (c) For an active, vested participant in a defined benefit plan, the plan sponsor must provide either (1) a benefit statement once every three years or (2) an annual notice describing the availability of a benefit statement and the manner in which the participant can obtain a benefit statement.

Questions investment manager's guideline statement should cover -pg443

How much risk is plan sponsor willing to take to achieve benchmark rate of return Time period for measurement of performance relative to objective Asset mix preference as it relates to stocks liability outlook for plan, and what should funds investment strategy be in light of this outlook. Sponsors cash flow or liquidity requirements discretion manager is permitted regarding foreign investment, private placement, options, futures, hedge funds, etc.

What are hybrid retirement plans, and why are they used by plan sponsors? (Retirement Plans, p. 379)

Hybrid retirement plans are retirement plans that blend attributes of traditional defined benefit pension plans and traditional defined contribution plans. Hybrid retirement plans are implemented by plan sponsors in an effort to meet plan objectives that these plan sponsors find difficult to achieve with either traditional defined benefit or traditional defined contribution plans, alone or in pairs.

Before any performance is measure, agreement must exist on the correct definition for the return that is being measure. Two alternative definition, IRR and TWROR. Explain the value and shortcoming of IRR and how the TWROR is computed. -pg444-45

IRR is valuable in that it allows the sponsor to determine whether investment is achieving rate of return assumed for actuarial calc. largely ineffective as a means of evaluating investment managers because it is contaminated by effects of timing of investments and withdrawals TWROR value is computed by dividing the time interval under study into sub-intervals whose boundaries are the dates of cash flows into and out of the fund by computing the IRR for each sub-interval. The TWROR is the geometric average for the rates for these subintervals, with each rate having a weight proportional to the length of time in its corresponding subinterval.

Has IRS given any guidance on whether plan sponsors can perform plan transactions electronically without jeopardizing the plan's qualified status? (Retirement Plans, p. 510)

IRS has stated in Notice 99-1 that where IRC or regulations do not specify how a particular transaction is to be conducted (e.g., in writing), then a plan may perform the transaction electronically without jeopardizing the plan's qualified status under IRC. IRS provided various examples of activities that can be performed with the assistance of electronic media. The enumerated actions include the following: (a) Enrolling participants in a plan (b) Designating employee contribution rates (c) Designating beneficiaries (except where spousal consent is required) (d) Designating investment allocation of future contributions and currently held assets (e) Receiving and responding to participant information requests (f) Electing direct rollovers. With respect to those plan activities for which IRS has detailed a specific means of execution, electronic media may not be used unless IRS has issued specific guidance permitting such use.

Describe the Best Interest Contract (BIC) Exemption and the conditions under which a fiduciary would qualify for it. (Reading A, How Are the Fiduciary Duties under the DOL's New Fiduciary Advice Rule Different from the Securities Laws?, Study Guide Module 11, p. 28)

If an advisor is subject to the fiduciary provisions of ERISA and IRC because he or she provides fiduciary investment advice, then the advisor is prohibited from receiving certain types of compensation, such as commissions, and from providing advice regarding proprietary products or investments paying additional fees. In order to permit such advice and commission-based compensation, the advisor must meet the conditions of a prohibited transaction exemption. In the Fiduciary Advice Rule, DOL issued a new class exemption, the BIC Exemption. To qualify for the BIC Exemption, financial institutions and advisors must abide by certain conditions, including: (a) Advisors to employee benefit plans and IRAs must abide by the DOL's newly adopted impartial conduct standards, and financial institutions must adopt policies and procedures designed to ensure that their individual advisors adhere to these standards. • The impartial conduct standards require that financial institutions and advisors provide investment advice that is, at the time of the recommendation, in the best interest of the retirement investor. • Financial institutions and advisors must ensure that they will not receive, directly or indirectly, compensation for their services that is in excess of reasonable compensation within the meaning of the prohibited transaction exemptions for service providers. • The impartial conduct standards require that financial institutions and advisors ensure that their statements about the recommended transaction, fees, compen-sation, conflicts of interest, and any other matters relevant to an investor's in-vestment decisions will not be materially misleading at the time they are made. (b) Financial institutions seeking to rely on the BIC Exemption must also affirmatively represent in writing that they and their advisors are fiduciaries under ERISA and IRC and must warrant that they have written policies in place designed to ensure that their advisors adhere to the impartial conduct standards. (c) With respect to IRAs and other plans that are not subject to Title I of ERISA, financial institutions seeking to rely on the BIC Exemption must agree that they and their advisors will adhere to the exemption's standards in a written contract that is enforceable by retirement investors. (Such a contract may not include any provision disclaiming or otherwise limiting liability, waiving the right to bring or participate in a class action, or agreeing to arbitrate or mediate individual claims in venues that are distant or that otherwise unreasonably limit the ability to assert the claims safeguarded by the BIC Exemption.)

What notice requirements must a plan sponsor abide by to receive relief from liability when investing participant assets in default investment alternatives? (Retirement Plans, p. 198)

If the plan sponsor is to receive relief from liability, each participant must receive, within a reasonable period of time before each plan year, a notice explaining the employee's right under the plan to designate how contributions and earnings will be invested and explaining how, in the absence of any investment election by the participant, such contributions and earnings will be invested. Additionally, participants must have a reasonable period of time after receipt of such notice and before the beginning of the plan year to make such a designation. Such a notice must be sufficiently accurate and comprehensive to apprise the employee of such rights and obligations, and it must be written in a manner calculated to be understood by the average employee eligible to participate. The relief provided by the regulation is conditioned on the use of certain investment alternatives.

In addition to the aforementioned benefit statement that must be supplied upon request, list other items that must be given to employees upon request and/or made available for examination. (Retirement Plans, p. 503)

In addition to benefit statements, there are other items that must be given to employees upon request and/or made available for examination at the principal office of the plan administrator and at other locations convenient for participants. These items include: (a) Supporting plan documents (b) The complete application made to IRS for determination of the plan's tax-qualified status (c) A complete copy of the plan's annual financial report (d) A plan termination report (IRS Form 5310) should the plan be terminated. The locations at which documents must be made available include any distinct physical location where business is performed and in which at least 50 participants work. Plan materials need not be kept at each location as long as they can be provided there within ten working days after a request for disclosure. The employer may charge for reproduction of all materials requested unless the material falls in a category where it must be automatically furnished. Any item automatically distributed by mail must be sent by a class of mail that ensures timely delivery.

In addition to the times when employees routinely interact with their employers regarding employee benefits, why would an employer initiate contact with an employee about benefit programs? (Reading A, Effective Benefit Plan Communication, Study Guide Module 10, p. 28)

In addition to the times when employees routinely interact with their employers regarding employee benefits, employers may choose to initiate contact with employees regarding employee benefit programs. An employer may initiate contact for various reasons. One of the primary reasons for initiating contact may be to enhance employee understanding and appreciation of employee benefit programs. Especially since employers have placed more responsibility on employees for managing risk with participant-directed defined contribution (DC) plans, the employer has a stake in ensuring that employees understand plan features and make the best use of these programs. An employer may initiate contact to provide investment education. Efforts to improve knowledge, understanding and outcomes with these plans can actually be beneficial to the employer, in demonstrating that the employer as a plan sponsor, is fulfilling fiduciary responsibilities.

What factors are considered in assessing the efficiencies of retirement savings structures? (Retirement Plans, p. 572)

In making decisions concerning retirement savings structures, an individual is assessing the tax efficiencies of the retirement savings vehicle, the costs associated with the investment products and the risks of either asset classes or specific investments. The risks of asset classes should not be assessed in isolation but should include consideration of other asset classes held, both in retirement savings vehicles and in other savings vehicles outside the retirement plans. These other holdings combined with the assets held within retirement savings plans comprise the individual's master portfolio. The master portfolio includes the entire set of of assets held by the individual. The implicit after-tax return is the compound annual return that an individual needs to earn on a given amount of pretax earnings to achieve a certain after-tax balance at the time of withdrawal. Not only does the type of plan holding the asset determine the implicit after-tax return, but other factors influence this rate of return as well. Among these factors are the holding period for the asset when held in a taxable account (i.e., short term (less than one year) or long term (one year or more)), type of investment return earned (i.e., dividend, interest payment or capital gain) and the individual's tax rate that can either decrease or increase over time.

Describe the decisions an employer must make in the design phase of developing plan investment provisions. (Retirement Plans, pp. 555-558)

In the design phase, the employer must make a series of decisions about plan assets. The first is to consider what asset classes will be offered. This decision will be influenced by administrative costs, risk-and-return characteristics, plan objectives and participant needs. The next issue in the design phase is whether to offer asset classes as distinct investment options, from which employees will choose their own mix, or to combine them into predetermined sets of diversified portfolios reflecting different risk-and-return characteristics. Each asset class in and of itself also can be diversified, combining different management styles such as growth and value in an equity portfolio, long-term and short-term fixed income strategies, and a stable of guaranteed investment contract (GIC) providers in a GIC portfolio. (GICs are investment options for employees under certain kinds of qualified retirement plans provided under a contract with a life insurance company. The insurer guarantees the principal and interest of the GIC for the specified period of time. Employees should remember, however, that the security behind a GIC is the financial soundness of the insurance company providing it. Lifecycle funds have become more popular investment options that employers have added to the mix of asset classes. Once the asset classes or portfolios to be offered have been determined, appropriate investment objectives for each asset class must be established. Within each asset class, the employer must also decide whether to pursue an active or passive investment style. Investment managers must be selected and their performance monitored as well.

What are index funds, and how have they performed relative to actively managed funds? (Retirement Plan Investing Essentials, p. 15)

Index funds are unmanaged funds seeking to match a chosen market index. Vanguard describes the investment objective of its Standard & Poor's (S&P) 500 Index fund as: Designed to track the performance on the Standard & Poor's 500 Index, a widely recognized benchmark of U.S. stock performance that is dominated by the stocks of large U.S. companies. The fund attempts to replicate the target index by investing all, or substantially all, of its assets in the stocks that make up the index, holding each stock in approximately the same proportion as its weighting in the index. As for the performance of index funds: Of the actively managed funds in operation since the mid-1970s when the first index fund was created, only one in four has managed to outperform Vanguard's S&P 500 fund. (Vanguard changed the basis for its 500 Index Fund and no longer tracks to the Standard & Poor's 500 Index.)

How do international funds differ from global funds? (Retirement Plan Investing Essentials, p. 28)

International funds tend to concentrate primarily on non-U.S. stocks, but global funds tend to keep a minimum of 25% of their assets in the United States.

How do investors misjudge when they attempt to rationally review performance data in making investment decisions? (Retirement Plans, pp. 192-193)

Investors seem to overweight past performance as an indicator of future performance, particularly when reviewing the performance of mutual funds. Funds routinely caution prospective investors that past performance is not a guarantee of future performance. Nevertheless, investors disregard this caution. Investors may be relying on the only information, or what they consider the best information, that they possess regarding a gauge of the fund's performance. However, all too often the investor is more likely to experience reversion to the mean in future years, rather than continued above-average performance by a given fund manager. It also should be noted that fund families often heavily advertise those funds within their family of funds that have turned in a stellar performance. Many investors may be reacting to the advertising stimuli they are receiving to a greater extent, rather than making a reasoned determination as to where to best direct their investable funds.

How did various major financial asset classes compare in terms of their respective returns and standard deviations over significant periods of time? (Retirement Plan Investing Essentials, pp. 55-56—Table 2-6)

Large common stocks, as measured by the well-known Standard & Poor's (S&P) 500, had a geometric mean annual return over an 85-year period of 9.6% (rounded). Hence, $1 invested in this market index at the beginning of 1926 would have grown at an average annual compound rate of 9.6% over this very long period of time. In contrast, the arithmetic mean annual return for large stocks was 11.5%. The best estimate of the "average" return for stocks in any one year, using this information, is 11.5%. The standard deviation for large stocks during this time period was 19.9%. Smaller common stocks have greater returns and greater risk relative to large common stocks. Smaller here means the smallest stocks on the New York Stock Exchange (NYSE) and not the really small stocks traded in the over-the-counter market. The arithmetic mean for this series is much higher than for the S&P 500, typically 5 or 6 percentage points higher. However, smaller common stocks have much larger standard deviations and, therefore, the difference between their geometric and arithmetic means is greater. Corporate and Treasury bonds have geometric means that are roughly 50% to 60% of the S&P 500, at 5.9% and 5.4%, respectively, but the risk is considerably smaller. Standard deviations for the bond series are less than half as large as that for the S&P 500. Finally, as expected, T-bills have the smallest returns of any of the major assets, shown at 3.6%, as well as by far the smallest standard deviation.

Comment on the rich history of innovation within ERISA plans. (Reading B, Prudent Management of Innovative Investments in ERISA Plans, Study Guide Module 10, p. 30)

Many innovative investment developments have occurred since the passage of ERISA in 1974. Among these innovative products that have been included within ERISA-qualified plans are such items as: (a) Index mutual funds (first introduced by Vanguard in 1975) (b) Stable value investment options (offered within DC plans in the late 1970s) (c) 401(k) plans (developed and introduced in January 1982) (d) Emerging market mutual funds (offered in 1989) (e) TDFs (first introduced by Barclays Global Investors in 1993) (f) Custom TDFs (discussed by DOL in 2013) (g) TDFs with lifetime income options (introduced in 2014).

Do investors realistically assess their investing ability, or do they exhibit an inflated assessment of their investing prowess? (Retirement Plans, p. 193)

Many investors have an undue level of confidence that contrasts with reality when it comes to assessing their personal record of investment success. Those investors whose investing records appear to be abysmal seem to indicate in surveys that they are the most confident about their investing abilities. Researchers have found an inverse correlation between investor overconfidence and knowledge. In a retirement confidence survey, a significant percentage of those who were confident about their retirement were, in fact, not saving anything toward their retirement!

Describe characteristics of money market funds. (Retirement Plan Investing Essentials, pp. 11-12)

Money market funds involve neither redemption fees nor sales charges, but they do assess a management fee. The funds are not insured, and the interest they pay is credited on a daily basis. Their shares can be redeemed at any time by phone or wire. The shares of money market funds are targeted to be held constant at $1.00; therefore, there are no capital gains or losses on money market shares under normal circumstances. Money market funds can be divided into (1) taxable funds—holding assets such as Treasury bills, negotiable certificates of deposits (CDs) and prime commercial paper—and (2) tax-exempt funds—consisting of national funds that invest in short-term municipal securities and state tax-exempt money market funds that invest in the issues of a single state. Approximately 90% of money market assets are in taxable funds.

Explain the nine categories of investment styles that Morningstar, Inc., a well-known Chicago mutual fund research firm, uses for U.S. stock funds. (Retirement Plan Investing Essentials, pp. 13-14)

Morningstar characterizes a fund's investment styles using a nine-square grid to depict three investment styles (value, growth and blend) for each of the three capitalization (cap) sizes (large, mid and small). For example, a mutual fund designated as a large value fund (the term value fund is defined in the next question) would be investing primarily in stocks that are considered undervalued with a median market cap of $5 billion or more.

How successful is market timing? Explain. (Retirement Plan Investing Essentials, pp. 138-139)

Much of the empirical evidence on market timing comes from studies of mutual funds. Several studies found no evidence that funds were able to time market changes and change their risk levels in response. (Also, market timing often involves high brokerage commissions and taxes.) But the biggest risk of market timing is that investors will not be in the market at critical times. Investors who miss only a few key months may suffer significantly.

Since the expected return of a portfolio is a weighted average of the expected returns of the individual securities comprising the portfolio, does it follow that a portfolio's risk is the weighted average of the risk of the individual securities comprising the portfolio? (Retirement Plan Investing Essentials, p. 77)

No, it does not follow. Although the expected return of a portfolio is a weighted average of its securities' expected returns, portfolio risk is not a weighted average of the risk of the individual securities contained in the portfolio. In fact, portfolio risk is always less than a weighted average of the risks of the securities in the portfolio unless the securities have outcomes that vary together exactly, which is an almost impossible occurrence.

Does behavioral finance say or imply that people can beat the market because of irrationality and behavioral biases? (Retirement Plan Investing Essentials, p. 165)

No. Behavioral finance does not either say directly or imply that people can beat the market because of the irrationality and behavioral biases of other investors. Such a claim is an often-made basic misunderstanding of behavioral finance. What behavioral finance says is that market prices and fundamental values can diverge because of psychology. Opportunities may be present as a result of this divergence; however, investment managers will not necessarily try to exploit the opportunities. Why? Informed investors may not be willing to take the risk involved to try to exploit these opportunities, or constraints exist that prevent them from doing so.

Must defined benefit hybrid plans place investment decisions and the resulting risk and reward solely with plan sponsors? Explain. (Retirement Plans, p. 386)

No. Defined benefit hybrid plans need not necessarily place investment decisions and the resulting risk and reward solely with plan sponsors. Defined benefit hybrid plans can include design features that shift investment risk-and-reward opportunities to participants in whole or in part. Some varieties of cash balance and other defined benefit hybrids are creative in how they assign risk and reward. For example, a minimum balance pension plan is a cash balance variant that offers participants the greater benefit of either a traditional defined benefit pension plan (often final average pay) or the benefit accumulated by the cash balance method (based on career average pay). Other cash balance variations give employees the option of linking the growth rate of their accounts with an equities index, introducing the prospect of both higher returns and more risk to participants.

Discuss the perspective of professional wealth managers when assembling a retirement investment portfolio design for a client. (Retirement Plans, p. 575)

Not only has today's wealth manager been taught that the professionally correct process for portfolio design is the development of a sound and well-diversified investment policy, modern law (Employee Retirement Income Security Act (ERISA), the Restatement of the Law Third, Trusts,* Uniform Prudent Investor Act) mandates adherence to this process. Because of these underlying investment theories and the nature of the law, many wealth managers implement investment strategies using a prescribed methodology: The investment process wealth managers currently use for designing and implementing portfolio strategies for their clients has been modeled after investment policy design and implementation strategies developed for large tax-exempt institutional clients. This has led to the design of multi-asset-class/style portfolios, implemented by selecting style-consistent active managers. In selecting an asset class and style universe, wealth managers tend to mimic the universe reflected in the Morningstar style boxes and categories. Although it is unlikely that a wealth manager will use all, or even most, of these class/styles for a single client, a policy will typically include at least six and rarely less than four asset classes/styles. Although this investment methodology is widely practiced, it is being questioned because of the potentially higher expenses that can accompany it. Using several actively managed portfolios means higher costs associated with active versus passive management as well as costs for the professional wealth manager making investment recommendations at the overall portfolio level. In a low-return environment, the effect of these cumulative investment management expenses can adversely affect portfolio return. * In 1992, the American Law Institute published the Restatement of the Law Third, Trusts Prudent Investor Rule, updating that series' fiduciary investment standard to incorporate modern portfolio theory.

When new legislation occurs regarding retirement plans, when is the effective date by which a plan sponsor must comply with the change, and how must the sponsor comply with the law during the interim period before the plan document is amended? (Retirement Plans, p. 533)

Often, the effective date for any required change because of new legislation is the start of the following plan year after the legislation is passed by Congress, even though the plan document is not required to be amended for a period of up to two or three years. For example, the Pension Protection Act of 2006 (PPA) had several provisions that became effective on the first day of the plan year that began on or after January 1, 2007. Even though these changes were expeditiously implemented as directed by PPA, the plan documents affected were not required to be formally amended until the last day of the plan year that began in 2009. Therefore, a plan sponsor needed to operate in compliance with the terms of PPA for up to three years before the plan document was actually amended to reflect these changes. New legislation creates two distinct challenges for a plan sponsor: First, the plan spon-sor must determine what elements of the plan will be altered due to the new legislation. Second, the plan must be consistently administered according to the altered terms of the plan, in the same way that it will be after the amendment process has occurred. A plan that ignores operating in a manner directed by the new legislation until the for-mal amendment deadline would be found to be out of compliance with the law. Failure to make these plan changes in a timely manner places the plan at risk of being penal-ized by the Internal Revenue Service (IRS) or the Department of Labor (DOL). There-fore, a procedure should be established that clearly identifies how the plan will operate during this interim period until the plan document has been formally amended.

What is considered one of the best known references by investors for assessing mutual fund performance? (Retirement Plan Investing Essentials, p. 24)

One of the best known assessments of mutual fund performance among investors is the rating system developed by Morningstar.

Briefly describe two ways to test for weak-form efficiency. (Retirement Plan Investing Essentials, p. 152)

One way to test for weak-form efficiency is to statistically test the independence of stock price changes. In other words, if trends (patterns) in stock prices do not exist, the market has (at least) weak-form efficiency. Another way to test for weak-form efficiency is to test specific trading rules that use past stock price and volume data. If such trading rules produce risk-adjusted returns beyond that of simply buying and holding, after deducting costs, the market would not be efficient—even in a weak form.

What are pension equity plans? (Retirement Plans, pp. 381-383)

Pension equity plans are a type of defined benefit hybrid retirement plan where benefits are based on both final average pay and the percentage credits that participants receive each year while they are plan participants. Upon termination of employment or retirement, the sum of percentage credits is applied to final average pay to determine the lump-sum benefit, which is portable. The percentages upon which credits are based can be relatively flat but often increase in steps with age or length of service. Although the benefits earned under a pension equity plan are expressed as a lump sum, participants must have the option to receive these benefits in the form of an annuity distribution. The age- or service-weighted credits and final average pay formula make pension equity plans appealing to older workers and persons hired in midcareer who have fewer years to accrue benefits.

What is pension wear-away? (Retirement Plans, p. 387)

Pension wear-away is a term used to describe a condition occurring when a traditional defined benefit plan is converted to a cash balance plan. This condition occurs for participants with longer service records because of the difference in benefit accrual patterns between the two different types of plans. Employees who have reached or are nearing the final stage of a traditional defined benefit plan, generally in the later years of a career when the benefit accrual rates increase rapidly, will experience a sudden decrease in accrual rates and expected benefits under a cash balance plan with less of the overall benefit accrual taking place in later years. Although pension wear-away occurred in early conversions of traditional defined benefit plans to cash balance plans, PPA prohibited wear-away in conversions occurring after June 29, 2005. Additionally, if a plan had already converted and was in existence on June 29, 2005, amended interest-crediting rules did not apply until plan years beginning after 2007, unless the employer elected to have those rules apply as of June 29, 2005.

What part does plan complexity play in making communication of employee benefits a challenge for plan sponsors? (Reading A, Overview of Plan Administration, Study Guide Module 9, p. 22)

Plan complexity makes communicating employee benefits a challenge for plan sponsors. Increased investment choices with participant-directed accounts, multiple program choices in flexible benefits programs, corporate mergers, and continuing market, technology and legal changes contribute to the complexity.

Does a plan sponsor benefit by converting from a traditional defined benefit plan to a cash balance plan structure? (Retirement Plans, pp. 380-381)

Plan sponsors may benefit from conversion of a traditional defined benefit plan to a cash balance plan structure because, as a career average plan, it is likely to be less expensive than a final pay defined benefit plan. Additionally, the plan sponsor of a cash balance plan may guarantee an interest rate below what the sponsor expects it can generate on actual plan investments, and the higher rate of return reduces the future plan costs for the sponsor. (This difference is sometimes referred to as the investment differential.)

Describe some potential barriers to foreign investments. (Reading A, The Case for international Diversification, Study Guide Module 4, pp. 49-53)

Potential barriers to foreign investments include all the following: (1) Unfamiliarity with foreign markets—Cultural differences are a major impediment to foreign investments. Investors are often unfamiliar with foreign cultures and markets. (2) Political risk—Many emerging markets have periodically suffered from political, economic or monetary crises that badly affected the value of local investments. (3) Market inefficiencies—A key problem is that of illiquidity. Some markets are very small; others have many issues traded in large volume. Also, another liquidity risk is the imposition of capital controls on foreign portfolio investments. Such capital control prevents the sale of a portfolio of foreign assets and the repatriation of proceeds. In addition, in some countries, especially emerging countries, corporations do not provide timely and reliable information on their activity and prospects. Finally, another market efficiency issue is that some countries have historically been quite lax in terms of price manipulation, insider trading and corporate governance. (4) Regulations—In some countries, regulations constrain the amount of foreign investment that can be undertaken by local investors. For example, institutional investors are sometimes constrained on the proportion of foreign assets they can hold in their portfolios. Also, some countries limit the amount of foreign ownership in their national corporations. (5) Transaction costs—The transaction costs of international investments can be higher than those of domestic investments, especially when trying to determine a so-called average commission for bonds. Also, management fees charged by international money managers tend to be higher than those charged by domestic money managers. (6) Taxes—Withheld taxes exist on most stock markets. The country where a corporation is headquartered generally withholds an income tax on the dividends paid by the corporation. This tax can usually be reclaimed after several months; this time lag creates an opportunity cost. (7) Currency risk—This type of risk can be a major cause of the higher volatility of foreign assets but is often overstated.

Explain the extent to which DOL has clarified the ability of plan administrators to disclose plan information using electronic media. (Retirement Plans, p. 509)

Previously, safe harbors were only provided when issuing SPDs, SMMs and SARs. The final regulations issued in April 2002 expanded the scope of safe harbors to all ERISA Title I disclosures. Such items as pension plan investment information, material on pension plan loans, responses to written requests from plan participants and beneficiaries, and notices relating to qualified domestic relations orders may now be conveyed in electronic form. Compliance with the regulation meets the general ERISA requirement that disclosure be "reasonably calculated to ensure actual receipt."

A passive investment strategy is characterized by a broadly diversified buy-and-hold portfolio aimed at replicating the return on some broad market index at minimum cost. Explain why a passive investment strategy may be attractive to a pension plan sponsor. (Retirement Plans, pp. 454-455)

Proponents of the passive strategy argue that as the stock market becomes increasingly efficient, it is more difficult for investment managers to consistently outperform the market. If actively managed funds do indeed encounter difficulties producing a gross rate of return superior to that of the market, it will obviously be even more difficult to produce a superior return on a net basis (after the effects of fees and transaction costs have been accounted for).

Describe the following types of investment risk: Purchasing Power, Business, Interest Rate, Market, Specific -pg441-442

Purchasing Power risk reflects the relationship between nominal rate of return on investment and increase in the rate of inflation. Business risk involves prospect of corp issuing the security suffering a decline in earnings power that would adversely affect ability to pay interest, principal or dividends. Interest rate risk comprises well known inverse relationship between interest rates and long term bond prices. When interest rates rise, value of long term bonds fall. Market risk is stock reaction to change in the market. Price of one stock may rise or fall half as fast as another on average, while another might change twice as fast. Quantified by a measure known as BETA Specific risk is risk that is intrinsic to a particular firm.

What are the two major implications of qualifying as a fiduciary under ERISA and/or IRC? (Reading A, How Are the Fiduciary Duties under the DOL's New Fiduciary Advice Rule Different from the Securities Laws?, Study Guide Module 11, p. 27)

Qualifying as a fiduciary not only imposes a variety of stringent fiduciary duties, but it also complicates compliance with the prohibited transaction rules under both ERISA and IRC.

List the three common objectives for employee benefits communications regardless of whether print or non-print media are used. (Reading A, Effective Benefit Plan Communication, Study Guide Module 10, p. 27)

Regardless of the technological advancements, the fundamental nature of employee benefits communications remains the same. Whether print or non-print media are used, their objectives do not change and can be classified into three areas: (a) Adhere to statutory reporting and disclosure requirements. (b) Support employee benefits cost-containment strategies. (c) Support human resource recruitment and retention objectives.

How does the fact that individual investors are loss-averse tend to be problematic for individual investors when making decisions about their retirement investments? (Retirement Plans, pp. 190-191)

Research indicates that individuals suffer more remorse as a result of losses than they experience satisfaction or pleasure for their gains. Essentially, individuals do not equally rate gains and losses of equal magnitude. It has been found that, on average, if a gain and loss were of the same magnitude, individuals felt more remorse for losses by a factor of two or 2.5 times the satisfaction felt for a gain. The implication of this finding is that convincing individuals to forgo present consumption for a future payment at a later date may be difficult. In short, it is a challenge from the outset to convince many individuals to save for retirement.

Summarize the process that investment committees must engage in when considering use of innovative investments within an ERISA-qualified plan. (Reading B, Prudent Management of Innovative Investmnt in ERISA Plans, Study Guide Module 10, p. 35)

Responsible plan fiduciaries must engage in an objective, thorough and analytical search; avoid self-dealing and conflicts of interest; consider the risk associated with the investment versus alternatives; consider all costs in relationship to the services provided; and focus on improving outcomes. Finally, they must consult with experts when that expertise is lacking in themselves and always periodically monitor previously made decisions. It should be possible to re-create the decision-making process years later by reviewing the minutes. Without documentation, one might as well assume the process never happened. Ultimately the plan fiduciaries making innovative investment products available through an ERISA-qualified plan will be judged on their documented process—which includes duty of loyalty, exclusive purpose, and the duty to act as a prudent expert to investigate and monitor while taking into account the needs of plan participants.

What is the risk, that is, the standard deviation, of the returns in Learning Objective 1.1? (Retirement Plan Investing Essentials, pp. 77-78)

Return% Difference* Diff Sq. Diff Sq. X Probability 4 -2 4 0.40 5 -1 1 0.20 6 0 0 0.00 7 1 1 0.20 8 2 4 0.40 The standard deviation is the square root of 1.2, or 1.095% * This is the difference between the possible return (R) and the expected return (ER) (6%, as calculated in Learning Objective 1.1)

Calculate the expected return of security A given the following information. (Retirement Plan Investing Essentials, pp. 72-74)

Return(%) Probability 4 0.10 5 0.20 6 0.40 7 0.20 8 0.10 The expected return is simply the sum of the products of the returns multiplied by the probabilities: 4 X 0.10 = 0.40 5 X 0.20 = 1.00 6 X 0.40 = 2.40 7 X 0.20 = 1.40 8 X 0.10 = 0.80 Total = 6.00 The expected return is 6%

How is risk adjusted rate of return utilized in portfolio measurement. -pg447

Risk adjusted rate of return can be used to measure risk-adjusted performance and to compare portfolios with different risk levels developed by actual portfolio decisions.

What is a risk premium? (Retirement Plan Investing Essentials, p. 54)

Risk premium is the additional return investors expect to receive, or did receive, by taking increased amounts of risk. For example, the difference between stocks and a risk-free rate (proxied by the return on T-bills) is referred to as the equity risk premium.

How do investors typically measure risk when assessing investments? (Retirement Plan Investing Essentials, pp. 51-52)

Risk reflects the chance that the actual outcome of an investment will differ from the expected outcome. If an asset's return has no variability, in effect it has no risk. Thus, a one-year Treasury bill (T-bill) purchased to yield 10% and held to maturity will, in fact, yield (a nominal) 10%. No other outcome is possible, barring default by the U.S. government, which is typically not considered possible. Investors typically equate risk by the dispersion or with the variability of returns, specifically how rates of return vary over time. The risk of financial assets can be measured with an absolute measure of dispersion, or variability of returns, called the variance.

What have historical studies demonstrated with respect to the risk-return characteristics of the major classes of investments? -pg442-43

Riskiest investments also returned the highest yields. common stocks provide the highest annual return, with small company stocks having CAGR of 12% and large company stocks having 10% CAGR. Must be viewed after effect of inflation has been removed to find real rate of return.

How does SEC regulate insider trading? (Retirement Plan Investing Essentials, pp. 155-156)

SEC requires insiders (officers, directors and owners of more than 10% of a company's stock) to report their monthly purchase or sale transactions to SEC within two business days except when SEC may determine that the two-day period is not feasible. This information is then made public. Though insiders previously were required to report their prior monthly transactions by the tenth of the following month, reporting to SEC was changed to two business days by the Sarbanes-Oxley Act of 2002. Several studies have indicated that corporate insiders consistently earned abnormal (excess) investment returns on their stocks. These investors substantially outperformed the market when they made large trades. Nevertheless, investors should be aware that, for a variety of reasons, insider transactions can be very misleading or simply of no value as an indicator of where a company's stock price is likely to go. Subsequent research has disputed some of these findings after deducting transaction costs and adjusting for differences in firm size and price multiples.

Discuss administrative issues that need to be addressed in structuring the investment provisions of a DC plan. (Retirement Plans, pp. 553-555)

Several administrative issues need to be addressed in structuring the investment provisions of a DC plan. These administrative issues include: (a) Frequency of valuation. How often will plan assets and account balances be valued for purposes of processing loans, distributions, withdrawals and investment election changes? (b) Frequency of change. How often will employees be permitted to change their investment choices? The Section 404(c) safe harbor provisions require that employees must be permitted to make changes at least quarterly, and more often for more volatile investment options. (c) Default provisions. Employers must provide some sort of default option in the event an employee fails to make an investment election for contributions. PPA has clarified standards for default options and exempted plan sponsors from fiduciary liability when they abide by the act's requirements. (d) Negative elections. Instead of requiring an employee to elect to participate in a DC plan, employees are deemed to have elected to defer a percentage of their eligible compensation as a plan contribution unless they affirmatively elect a different deferral amount or elect not to participate in the plan. (e) Employee communications. Employee communication is a critical link in the long-term success of DC plans. DOL now requires that the employer offer participants sufficient information to enable them to make an intelligent choice among the investment options available to them. PPA provides a new prohibited transaction exemption allowing qualified fiduciary advisors to provide personally developed professional investment advice to assist plan participants in managing their retirement plan investments.

Define what is meant by soft-dollar arrangements as they relate to retirement plans. (Retirement Plans, pp. 540-541)

Soft-dollar arrangements occur when the standard fee charged for a service is greater than the actual cost incurred. For example, if it costs a brokerage firm 4¢ to execute a trade but the standard charge is 10¢, the brokerage firm could make the difference (6¢) available to the broker initiating the trade for use against the cost of various services. This might be used for services such as access to the brokerage firm's security analysis system. This practice is permitted under Securities and Exchange Commission (SEC) regulation 28(e). In the retirement plan world, this arrangement may provide services to the investment consultant used by the plan.

What are event studies, and how are they utilized in testing for market efficiency? (Retirement Plan Investing Essentials, p. 153)

Studies of stock returns to determine the impact of a particular event on the stock price are known as event studies. These studies allow researchers to control aggregate market returns while firm-unique events are examined.

What are subtransfer agent fees, and why must plan sponsors understand them? (Retirement Plans, p. 541)

Subtransfer agent fees are typically found in a participant-directed account plan, such as a 401(k) plan. The fees may be structured as a flat dollar amount per participant ($9) or as a small percentage of assets (10 basis points). Two potential issues arise with this fee. First, if it is charged as a percentage of assets, the fee will increase as the plan assets grow—even though there has been no corresponding increase in services provided to either the plan or the participant. The second issue relates to who receives this payment and what services have been provided for this fee. This arrangement often is used to cover the cost of the recordkeeping services. However, because different mutual funds provide different levels of subtransfer fees to the recordkeeper, this may cause the recordkeeper to encourage the use of one fund over another. Therefore, it is important the plan sponsor know what subtransfer fees are being received and the extent used to offset the overall cost of the services provided to the plan.

Describe the investment strategy that involves shifting among cyclicals, growth and value stocks. (Retirement Plan Investing Essentials, pp. 136-137)

Such a strategy is known as sector rotation. It involves shifting sector weights in the portfolio in order to take advantage of those sectors that are expected to do relatively better and to avoid or deemphasize those sectors that are expected to do relatively worse. It is clear that effective strategies involving sector rotation depend heavily on an accurate assessment of current economic conditions. Investors can pursue the sector investing approach using what are called sector mutual funds, or sector exchange-traded funds (ETFs).

Summarize how TDFs are designed to simplify retirement plan investing. (Reading B, Evaluating and implementing target-date portfolios, Study Guide Module 7, p. 24)

TDFs are designed to be easy for a participant to simply pick the funds that most closely correspond to his or her retirement date.

Explain how certain litigation avenues previously unavailable to aggrieved parties before the adoption of the Fiduciary Advice Rule would now be available. (Reading A, How Are the Fiduciary Duties under the DOL's New Fiduciary Advice Rule Different from the Securities Laws?, Study Guide Module 11, pp. 32-33)

The BIC Exemption, as it currently stands, requires certain contractual language that would create a private cause of action now; whereas heretofore such a litigation path in the absence of such contract language was probably unavailable. For plans subject only to Code Section 4975 (including IRAs), the BIC Exemption is now crucial because it requires that best-interest standard be part of a contract enforceable under state law. Thus, advisors previously subject only to fiduciary duties under the Advisers Act may now also be subject to state lawsuits to enforce the best-interest standard as part of a breach of contract claim, if that advisor is relying on the BIC exemption. Also, the Fiduciary Rule results in co-fiduciary liability under ERISA. Once fiduciary status attaches to an advisor, the fiduciary is potentially liable as a co-fiduciary for the breaches of other fiduciaries.

Explain the two parts of the ERISA prudence requirement. (Reading B, Prudent Management of Innovative Investments in ERISA Plans, Study Guide Module 10, p. 33)

The ERISA prudence requirement consists of two parts, procedural prudence and substantive prudence. Procedural prudence relates to the investigation, evaluation and decision-making processes. Substantive prudence refers to the duty to evaluate relevant information and make an informed decision based on that information. Courts have emphasized that the fiduciaries must conduct a thorough investigation and make decisions based on all of the information they have gathered.

What is the net asset value (NAV) of a mutual fund, and why is this number important to shareholders? (Retirement Plan Investing Essentials, p. 16)

The NAV is the market value of the securities in the mutual fund's portfolio less any liabilities, divided by the number of shares currently outstanding. This number is important because the fund is legally obligated to pay a shareholder this value if shares are redeemed. It changes daily as the value of the securities held changes and as income from the securities is received and paid out.

Describe the time intervals within which SPDs must be distributed to employees and beneficiaries, the time intervals within which SPDs must be updated and the overall need for the SPD to be in permanent form and current. (Retirement Plans, p. 503)

The SPD must be given to new employees within 90 days after they become participants and to beneficiaries within 90 days after they start receiving benefits. For new plans, the initial SPD must be given to participants within 120 days after establishment of the plan. New, complete SPDs must be filed and distributed at least every ten years. If there have been material changes since the last SPD was issued, however, the employer must file and distribute a new SPD every five years. The SPD must be in permanent form and must be current regarding all aspects of the plan and the information required by Title I of ERISA.

Discuss the intent of a plan's annual financial report and how this intent influences the information disclosed. Additionally, comment on the necessity to engage the services of an independent qualified public accountant. (Retirement Plans, p. 505)

The annual report is designed to require a complete disclosure of all financial information relevant to the operation of the plan. Thus, for example, it includes items such as a statement of assets and liabilities presented by category and valued at current market prices, changes in assets and liabilities during the year, and a statement of receipts and disbursements. It requests details, where applicable, for transactions with parties in interest, loans and leases in default or uncollectible, and certain reportable transactions (e.g., transactions involving in excess of 3% of the current value of plan assets). The report also requires information on plan changes made during the reporting period and on employees included or excluded from participation. Certain financial statements in the report have to be certified by an independent qualified public accountant. Insurance companies and banks are required, within 120 days after the end of the plan year, to furnish any information necessary for the plan administrator to complete the annual report. Plans that are fully insured are granted limited exemptions. These plans do not have to complete the financial information sections of the form, nor need they engage an accountant for audit or include an accountant's opinion. Plans with fewer than 100 participants have less complex filing requirements for their Form 5500.

Explain when an investor should use an arithmetic mean rate of return and when a geometric mean rate of return should be used. (Retirement Plan Investing Essentials, p. 47)

The arithmetic mean rate of return should be used when the investor wants to refer to the typical performance for a single period. That is the return that is "representative" of the periodic returns. The geometric mean rate of return is a better measure of the change in value (or wealth) over time (involving multiple periods). The geometric mean is preferable when the true average compound rate of growth is desired. Over multiple periods, such as years, the geometric mean shows the true average compound rate of growth that actually occurred—that is, the annual average rate at which an invested dollar grew, taking into account the gains and losses over time.

Describe the measure of performance known as the average annual total return that is used in the mutual fund industry. (Retirement Plan Investing Essentials, pp. 22-23)

The average annual total return is a hypothetical rate of return that, if achieved annually, would have produced the same cumulative total return if performance had been constant over the entire period. It is a geometric mean (see Module 2) and reflects the compound rate of growth at which money grew over time. This measure of performance allows investors to make direct comparisons among funds.

Apart from the plan-specific elements in the complaint of Sulyma v. Intel, why could this case, or one similar to it, have general precedential principles that could be very important for plan sponsors of DC plans offering customized target-date funds (TDFs) or other plan structures comprised of alternative investments? (Reading B, Prudent Management of Innovative Investments in ERISA Plans, Study Guide Module 10, pp. 29-30)

The case of Sulyma v. Intel, or one similar to it, could have general precedential principles important to plan sponsors of DC plans offering customized TDFs or other plan structures comprised of alternative investments. The case raised interesting issues that could have general applicability to many plan sponsors. The assertion was made that the investment committee dramatically altered the asset allocation model within the company 401(k) plans' custom target-date portfolios (TDPs) by increasing exposure to hedge funds and private equity investments. The general question raised for all plan fiduciaries is: Are innovative investments automatically imprudent if they differ from more standardized investments offered in most 401(k) plans? The suit claimed that the investment committee implemented an imprudent asset allocation model. Instead of implementing an asset allocation model consistent with prevailing standards adopted by investment professionals, it was alleged that the investment committee implemented an asset allocation strategy for the company TDPs that grossly overweighted allocations to hedge funds, commodities and international equities as compared to TDFs available in the marketplace. The lawsuit claimed modern portfolio theory (MPT) argues that low-cost, passive fund management with strictly disciplined asset allocation methodologies at the core of the investment process are the most effective and prudent approach to managing long-term, retirement-oriented assets such as TDPs, and that deviation from core investment strategies is imprudent.

What are some of the key considerations in the development of a retirement plan distribution strategy? (Retirement Plans, p. 587)

The development of a retirement plan distribution strategy involves at least the following key considerations: (a) Enumerating possible distribution alternatives and developing a means to evaluate which single distribution option or combination of distribution options meets the individual's retirement income needs and other objectives (b) Determining the adequacy of the expected income stream provided by a single or combination of distribution options to meet expected living expenses (c) Assessing the flexibility and risks related to various distribution methods (d) Making relevant investment decisions before the initiation of distributions and planning for future investment decisions, if available, with distribution choices (e) Planning for estate considerations should excess resources exist and distributions be sought for charities or beneficiaries.

When looking at the variability in financial asset return series, how are the geometric and arithmetic means related to the variability observed? (Retirement Plan Investing Essentials, p. 55)

The difference between the geometric and arithmetic means is related to the variability of the financial asset return series. The linkage between the geometric mean and the arithmetic mean can be approximated. If we know the arithmetic mean of a series of asset returns and the standard deviation of the series, we can approximate the geometric mean for this series. As the standard deviation of a series increases, the superiority of the arithmetic mean relative to the geometric mean also increases.

Distinguish the differences between what is contained in the plan document and the policy document regarding similar plan features. (Retirement Plans, p. 535)

The difference between what is contained in the plan document regarding plan features, like loans or hardships, and what is contained in the policy often is confusing. Generally, the elements within the policy are items that may change over time because of changing aspects of the business, internal procedures or even government regulations. While it is important to have a consistent policy applied evenly to all participants, it also is important that a plan administrator be able to respond to changing conditions without having to amend the formal plan document frequently. The policy document serves as the guide for the day-to-day functions of the plan. Of course, the actual plan document is the controlling instrument, and any policy or procedure developed must agree with the terms of the plan document.

What are the implications of mean reversion for investors? (Reading B, Evaluating and implementing target-date portfolios, Study Guide Module 7, p. 26)

The existence of mean reversion in long-term equity returns would in part imply that equity risk is generally lower for those with longer investment horizons; hence, equity allocations should be higher for younger investors versus older investors. Mean reversion would also, however, imply that one could successfully move in and out of mean-reverting assets (selling when reversion suggests future returns will be poor and buying when reversion implies returns will be higher) to improve overall returns. Investors' historical lack of success in doing so weakens the case for the simplest forms of mean reversion in returns.

Discuss the relevant information for a fiduciary to gather in connection with making a prospective plan investment. (Reading B, Prudent Management of Innovative Investments in ERISA Plans, Study Guide Module 10, p. 34)

The fiduciary must know the information that is relevant to the decision. It is not sufficient to gather quantities of data; the data must be the information needed to make a prudent and informed decision. And it is not sufficient for the fiduciary to rely only on what they know; rather, the fiduciary must consider whether the information they should know is relevant to the decision. Plan fiduciaries have a duty to determine both the appropriate methodology used to evaluate market risk and the information that must be collected to do so. Among other things, this would include, where appropriate, stress simulation models showing the projected performance of the proposed strategy and the plan's portfolio under various market conditions. Stress simulations are particularly important because assumptions that may be valid for normal markets may not be valid in abnormal markets, resulting in significant losses.

Describe typical types of fees assessed on mutual funds that are commonly the underlying investments in defined contribution plans. (Retirement Plans, pp. 539-540)

The following represent typical types of fees that are assessed on mutual funds that are commonly the underlying investments in defined contribution plans: (a) Sales charges (also known as loads or commissions). These are basically transaction costs for the buying and selling of shares. They may be computed in different ways depending on the particular investment product. (b) Management fees (also known as investment advisory fees or account maintenance fees). These are ongoing charges for managing the assets of the investment fund. They generally are stated as a percentage of the amount of assets invested in the fund. Sometimes management fees may be used to cover administrative expenses. The level of management fees can vary widely, depending on the investment manager and the nature of the investment product. Investment products that require significant management, research and monitoring services generally will have higher fees. (c) Other fees. This category covers services such as recordkeeping, furnishing of statements, toll-free telephone numbers and investment advice. It also covers costs involved in the day-to-day management of investment products. This expense category may be stated either as a flat fee or as a percentage of the amount of assets invested in the fund. (d) Some mutual funds assess sales charges (see the first item for a discussion of sales charges). These charges may be paid when an individual invests in a fund (known as a front-end load) or when he or he sells shares (known as a back-end load, deferred sales charges or redemption fees). A front-end load is deducted up-front and, therefore, reduces the amount of a participant's initial investment. A back-end load is determined by how long a person keeps the investment. Various types of back-end loads exist, including some that decrease and eventually disappear over time. A back-end load is paid when the shares are sold (i.e., if the participant decides to sell a fund share when a back-end load is in effect, he or she will be charged the load). (e) Rule 12b-1 fees. Mutual funds also may charge what are known as Rule 12b-1 fees, which are ongoing fees paid out of fund assets. Rule 12b-1 fees may be used to pay commissions to brokers and other salespersons, to pay for advertising and other costs of promoting the fund to investors, and to pay various service providers to a 401(k) plan pursuant to a bundled service arrangement. They usually range between 0.25% and 1% of assets annually. Some mutual funds may be advertised as "no-load" funds. This can mean that there is no front- or back-end load. However, there still may be an incremental 12b-1 fee.

What is the graphic depiction of how risk and required rate of return are related within the CAPM framework? (Retirement Plan Investing Essentials, p. 177)

The graphic depiction of how risk and required rate of return are related within CAPM is the security market line (SML). Required rate of return is on the vertical axis, and beta, the measure of risk, is on the horizontal axis. The slope of the line is the difference between the required rate of return on the market index and RF, the risk-free rate.

How does an investment decision involve the dual concepts of risk and expected return? (Retirement Plan Investing Essentials, pp. 49-50)

The investment decision can be described as a trade-off between risk and expected return. It is not sensible to talk about investment returns without talking about risk, because investment decisions involve a trade-off between the two. Investors must constantly be aware of the risk they are assuming, understand how their investment decisions can be impacted, and be prepared for the consequences.

Describe what characterizes an investment decision. (Retirement Plan Investing Essentials, pp. 125-126)

The investment decision, based on objectives, constraints and preferences, consists of two steps: (1) asset allocation and (2) security selection. The first step determines the largest part of an investor's success or failure.

What major areas should an employer consider when evaluating the investment provisions of a DC plan? (Retirement Plans, p. 549)

The investment provisions of a DC plan should be compatible with the plan sponsor's objectives. Three major areas to be considered are: (1) Fiduciary responsibilities (2) The role of employer stock (3) Administrative issues.

Explain the parallels between the tax law provisions within the Internal Revenue Code (IRC) and the labor law provisions within ERISA, as well as the two key labor law areas that have no corresponding sections within IRC. (Retirement Plans, p. 501)

The labor law provisions of ERISA contained in Title I of the act include many provisions that are virtually identical to the tax law provisions passed at the same time. Thus, for example, Title I has minimum participation, funding and vesting requirements, as well as joint and survivor protection for the spouses of employees. For the most part, however, jurisdiction and administration of these provisions have been assigned to the Internal Revenue Service (IRS) under the tax provisions—a notable exception being that the Department of Labor (DOL) was given jurisdiction over the determination of service for eligibility, vesting and benefit accrual. Title I, however, contains important provisions concerning two key areas: (1) reporting and disclosure and (2) fiduciary responsibilities. Except for some restrictions on prohibited transactions, there is no counterpart for these provisions in the tax law.

Describe the variations that exist in the construction of asset allocation glide paths for TDFs. (Reading B, Evaluating and implementing target-date portfolios, Study Guide Module 7, p. 25)

The large number of TDFs has led to varying approaches for constructing the asset allocation glide path. Variations exist in how quickly risk exposure diminishes as the transition out of equities is implemented, in the stock/bond/cash allocations, in how the glide path will operate once the target date is reached and in the asset classes being used.

What are earmarked investments, and what conditions must be satisfied by plan sponsors if they are to be exempted from fiduciary liability associated with these investments? (Retirement Plans, pp. 514-515)

The law permits a DC plan to be established on a basis that allows earmarked investments—that is, employees are allowed to direct the investment of their own accounts. Under these plans, sponsors and other plan fiduciaries might be exempt from liability for investment returns that result from participant choices, provided that participants are given the opportunity to exercise control over the assets in their individual accounts and can choose from a broad range of categories. DOL has issued regulations that provide statutory relief from fiduciary liability under these plans if certain requirements are met. Failure to comply with these requirements does not necessarily mean that the fiduciaries will be liable for investment performance; it simply means that this regulatory protection is not available. To ensure that participants have both control over their assets and the opportunity to diversify their holdings, the regulations: (a) Require the plan to provide participants with reasonable opportunities to give investment instructions to the plan fiduciary who is obligated to comply with these instructions (b) Require that a plan offer at least three "diversified categories of investment"—with materially different risk-and-return characteristics—that collectively allow participants to construct a portfolio with risk-and-return characteristics within the full range normally appropriate for a plan participant (c) Establish specific rules regarding participant transfer elections. Sponsors must allow at least quarterly elections for transfers in or out of the three diversified investment options that must, as a minimum, be offered under the plan, and more frequent transfers may be required if appropriate in light of the volatility of a particular investment.

Describe the issues addressed in a retirement plan's loan policy. (Retirement Plans, pp. 534-535)

The loan policy is the guiding document that provides answers to many of the administrative issues that arise for plan loans. In addition to stating the statutory limits or plan limits (if different) regarding participant loans, this policy also provides guidance regarding how certain events will be handled. For example, if a participant has an outstanding loan and then is terminated, what will happen? Will the plan permit the participant to continue making payments on the loan, or will the participant be required to repay the loan at that time or have the loan amount deemed to have been distributed (a taxable event)? By establishing policies in advance of situations, the staff administering the plan is able to provide consistent answers to questions from plan participants. This minimizes the risk that unfair treatment to one participant over another will occur. Participant loans continue to be an area of scrutiny by IRS during audits, so proper administration is very important.

What is the major role of the Securities and Exchange Commission (SEC) with regard to investment companies? (Retirement Plan Investing Essentials, p. 3)

The major role of SEC is to ensure full disclosure of fund information to investors, both prospective investors and current shareholders. However, investment companies are not insured or guaranteed by any government agency, including SEC.

What sources of information do analysts use in evaluating common stocks? (Retirement Plan Investing Essentials, p. 133)

The major sources of information used by analysts are presentations from the top management of the companies being considered, annual reports, and Form 10-K reports that must be filed with the Securities and Exchange Commission (SEC). (The 10-K is an annual filing with SEC for publicly traded companies. Financial statements and supporting details are provided. Form 10-K typically contains more financial information than the annual report to stockholders.)

Explain the rationale for plan sponsors' reluctance to provide investment education and how certain provisions of the Pension Protection Act (PPA) are likely to result in increased provision of investment advice to retirement plan participants. (Retirement Plans, pp. 515-516)

The majority of DC plans let participants direct how their account balances will be invested. While employers recognize the need to encourage employees to save, historically they had been reluctant to provide extensive education about investing these savings. This reluctance had been due, in part, to the fiduciary provisions of ERISA, which impose both responsibility and liability on those who provide investment advice for a fee or other compensation. The concern for these employers had been to distinguish between investment education and investment advice, recognizing that some efforts to provide only education may end up being interpreted as advice. This situation has undergone some change. With PPA providing guidelines on a plan sponsor's ability to appoint a fiduciary investment advisor, it is expected that more plans will make use of these services and be less concerned about prohibited transactions related to paying fees for investment advice.

Explain how an investor in a closed-end fund can have a gain or a loss even if the value of the portfolio of securities does not change. (Retirement Plan Investing Essentials, p. 17)

The market prices of closed-end funds can vary from their NAVs. A discount refers to the situation in which the closed-end fund is selling for less than the NAV. By purchasing a fund at a discount, an investor is actually buying shares in a portfolio of securities at a price below their market value. Therefore, even if the value of the portfolio of securities does not change, an investor in a closed-end fund can have a gain or loss if the discount narrows or widens.

What is the standard deviation for the returns shown in Learning Objective 1.6? (Retirement Plan Investing Essentials, pp. 52-53)

The mean return is 6.2%. Return% Mean Return Difference Difference Sq. 10 6.2 3.8 14.44 8 6.2 1.8 3.24 5 6.2 -1.2 1.44 -12 6.2 -18.2 331.24 20 6.2 13.8 190.44 540.80 The standard deviation is the square root of 135.20 (which is the quotient of 540.80/4), or 11.63%.

What is an exchange-traded fund (ETF)? (Retirement Plan Investing Essentials, pp. 5-6)

The newest form of the three major types of investment companies, an ETF is a basket of stocks that tracks a particular sector, investment style, geographical area or the market as a whole. Until recently, ETFs were passive (unmanaged) portfolios that simply held a basket of stocks; actively managed ETFs are now available. Like closed-end funds, ETFs trade on exchanges like individual stocks. That means they can be bought on margin and sold short anytime the exchanges are open. Like open-end funds, ETF shares are created and extinguished in response to the demand for them. Because ETF portfolios are typically unmanaged portfolios, they have much lower annual expense ratios compared to actively managed funds. A particularly appealing feature of ETFs to investors is their tax efficiency. Many ETFs report little or no capital gains over the years. Shareholders in mutual funds, in contrast, have no control over the amount of distributions their funds may make in a given year.

Stocks, bonds and cash play a major role in determining TDF asset allocation strategies. List several nontraditional asset classes and their potential advantages and flaws as a means of enhancing asset allocation strategies. (Reading B, Evaluating and implementing target-date portfolios, Study Guide Module 7, pp. 28-29)

The nontraditional asset classes include real estate investment trusts (REITs), commodities, private equity and currency. Among the alternative investment strategies are long/short and market-neutral approaches. These asset classes and strategies can offer several important potential advantages compared with investing in traditional stocks, bonds and cash, including the following: (1) potentially higher expected returns, (2) lower expected correlation and volatility vis-à-vis traditional market forces, and (3) the opportunity to benefit from market inefficiencies through skill-based strategies. However, it is important to note that it may be difficult to assess the degree to which these advantages can be relied upon. A study of actual returns shows that there have been extended periods when the inclusions of these nontraditional asset classes have led to significant underperformance.

What does the performance of professional investors seem to indicate regarding the efficacy of market efficiency? (Retirement Plan Investing Essentials, p. 167)

The performance of professional investors seems to indicate support for the view that markets generally tend to be highly efficient. When looking at data on the performance of mutual fund portfolio managers, the following statistics on performance should be noted: (a) Approximately 70% of mutual fund managers underperform over a ten-year period, and 80% underperform over a 20-year period. (b) Over a recent five-year period, only 6% of U.S. stock funds achieved a ranking in the top half for five consecutive 12-month periods. (c) Over a period of 30+ years, of the 139 mutual funds in existence for the entire period, only 20 funds outperformed by two percentage points or more. (d) Consider the consistency of performance of mutual funds over a recent ten-year period. Take the top 25% of large capitalization funds during the period 2001-2006. Over the subsequent five years, 2007-2011, only 12% of the earlier top performers were in the top 25%. (e) As for institutional portfolios, research shows that after adjusting for risk, well under 1% achieve superior results after all adjustment for costs.

Explain why, in the Markowitz analysis, the portfolio weights, or percentages of investable funds to be invested in each security, are the only variable to solve for in determining efficient portfolios. (Retirement Plan Investing Essentials, p. 99)

The portfolio weights are the only variable to solve for because all of the analysis of other components—the expected returns, the standard deviations and the correlation coefficients for the securities being considered—are inputs.

What are plan sponsor considerations for assessing an active management approach? (Reading B, Evaluating and implementing target-date portfolios, Study Guide Module 7, pp. 34-35)

The primary rationale for investing in actively managed TDFs is the potential of the funds to outperform a market or market segment as measured by an index benchmark. If markets are inefficient, there may be opportunities for outperformance. Nevertheless, costs are a significant determinant of active management's long-term success relative to an index. Plan sponsors that pursue the active approach must decide what combination of risk control and opportunity they want, how confident they are that a manager will outperform and the degree to which they themselves are willing and able to tolerate variability in returns relative to the benchmark. Sponsors should also understand a provider's justification for choosing one active manager over another.

Explain the nature of wealth management and the activities that characterize the wealth management process. (Retirement Plans, pp. 568-569)

The process of wealth management is, at its very core, a management activity. As with the general management approach utilized in directing the workings of an organizational enterprise, an effective wealth management process is an activity that involves planning, execution, ongoing monitoring, measurement of outcomes, accountability and, at times, creative new approaches. It also involves team activities, gathering together the expertise of different disciplines, combining the contributions of various specialties, employing project management skills and demonstrating leadership in achieving results. It is as much art as it is science. However, an important hallmark of a wealth management process is its integrative nature, which ensures that goals and objectives lead to overall wealth enhancement and security.

What is the rate of return over the entire period (2014-2018) in the previous question? (Retirement Plan Investing Essentials, pp. 41-42)

The rate of return is the cumulative wealth index minus 1, or 1.317 - 1.0 = .317 or 31.7%. (There might be some rounding differences between Table 2-1 on page 40 of the text and the Total Return figures used in the various examples of Chapter 2.)

What role does the retirement plan committee play in decisions regarding plan design? (Retirement Plans, p. 532)

The retirement plan committee plays a substantive role in decisions regarding retirement plan design. The actual decision regarding the plan design is typically a key responsibility of the retirement plan committee. While this decision should be made with advice supplied from consultants and legal advisors, it is important for the committee to determine the fit between the choice of various plan features and the unique benefit goals and human resource issues of the corporation. The initial design of the plan is important, but time is more often spent on ongoing amendments to the plan.

What is the charge given to the retirement plan committee, and what are its responsibilities? (Retirement Plans, pp. 531-532)

The retirement plan committee should be authorized by the corporation with the charge to make all decisions necessary regarding the administration of the retirement plan. This committee determines the plan design, selects the service providers, meets with legal counsel and reviews the overall status of the plan. As a committee, they meet at least annually but probably no more than quarterly—unless addressing some current, pressing issue. As an ongoing committee, the agenda focuses on investment performance review and administrative service provider review as well as addresses any legal or regulatory change that affects the retirement plan. In some companies, the retirement plan committee also may review and approve any written policies and procedures that are developed to assist in the day-to-day administration of the plan. Other companies permit the human resources or benefits department to develop and implement those policies and procedures without formal approval by the committee.

Describe how the scope of fiduciary regulation is narrower under the securities laws than under the Fiduciary Advice Rule. (Reading A, How Are the Fiduciary Duties under the DOL's New Fiduciary Advice Rule Different from the Securities Laws?, Study Guide Module 11, pp. 31-32)

The scope of fiduciary regulation in many respects is narrower under the securities laws than it is under the Fiduciary Advice Rule. Generally, fiduciary duties under the securities laws may not apply to brokers absent discretionary control over trading decisions. Additionally, the Advisers Act applies only to those "in the business" of providing investment advice. In contrast, the Fiduciary Advice Rule applies whenever investment advice is provided. Also, the Fiduciary Advice Rule is structured broadly to apply to anyone who provides investment advice to benefit plan investors, whereas the Advisers Act applies only to those who meet the definition of investment advisors. The Advisers Act also applies only to securities, whereas the Fiduciary Advice Rule broadly covers securities and "other property." Furthermore, the Fiduciary Advice Rule also applies broadly to recommendations about management decisions, such as whether to roll money from an employer-sponsored plan to an IRA. The BIC Exemption currently prohibits receipt of anything beyond "reasonable compensation" and regulates not only substantive requirements but also the fees charged for advisory services. Thus, the Fiduciary Rule touches conduct beyond just investment recommendations and places some limits on compensation arrangements, especially those that create potential conflicts.

What is the single most important risk affecting the price movements of common stocks? (Retirement Plan Investing Essentials, p. 124)

The single most important risk affecting the price movements of common stocks is market risk.

What are the six conditions to qualify for fiduciary relief when investing participant assets in default investment alternatives? (Retirement Plans, pp. 198-201)

The six conditions to qualify for fiduciary relief when investing participant assets in default investment alternatives are: (1) Assets must be invested in a qualified default investment alternative (QDIA). In order for an investment to qualify as a QDIA, five requirements must be met. (See Learning Objective 5.4 below.) (2) The participant or beneficiary on whose behalf assets are being invested in a QDIA had the opportunity to direct the investment of assets in his or her account but did not direct the assets. (3) The participant or beneficiary on whose behalf an investment in a QDIA may be made is furnished a notice within a reasonable period of time (at least 30 days) in advance of each subsequent plan year. The required notice can be furnished in the plan's summary plan description or summary of material modifications or as a separate notification. (4) The terms of the plan must require that any material provided to the plan relating to a participant's or beneficiary's investment in a QDIA (e.g., account statements, prospectuses, proxy voting material) be provided to the participant or beneficiary. (5) Any participant or beneficiary on whose behalf assets are invested in a QDIA must be afforded the opportunity, consistent with the terms of the plan (but in no event less frequently than once within any three-month period), to transfer, in whole or in part, such assets to any other investment alternative available under the plan without financial penalty. (6) The plan must offer participants and beneficiaries the opportunity to invest in a broad range of investment alternatives as specified in the Section 404(c) regulation. The Department of Labor (DOL) believes that participants and beneficiaries should have access to a sufficient range of investment alternatives to achieve a diversified portfolio with aggregate risk-and-return characteristics at any point within the range normally appropriate for the retirement plan participant or beneficiary. DOL believes that the application of the broad range of investment alternatives standard to the Section 404(c) regulation accomplishes this.

What factors contribute to the success of the partnership between plan service providers and plan sponsors? (Retirement Plans, p. 538)

The success of the partnership between plan service providers and plan sponsors depends on the ongoing communication among the various parties involved in the partnership as well as the quality and timeliness of the services being provided. The plan sponsor retains ultimate responsibility regarding the legal compliance of the plan as well as for ensuring that the participants' needs are being met by the plan service providers. Therefore, the plan sponsor needs to carefully monitor the actions of the service providers to ensure that they are administering the plan according to the terms of the plan document as well as adhering to the agreed-upon levels of service. Many companies establish a practice of formally assessing the service providers on a regular basis, such as every three to five years. In some cases, this may only be an internal review, while in other cases the plan sponsor may proceed with a full RFP process each time.

Describe why the tax aspect of an investment is important for a pension fund and why investments relative liquidity may be important to a pension plans investment manager -pg442

The tax aspect of an investment is important because of tax exempt status of pension fund. investment income of qualified retirement plans is tax-exempt, certain types of investments may not be as attractive to pension funds as they would for others. Liquidity refers to ability to convert investment into cash in a short time with little loss to principal. if pension plan does not have liquidity to sell it may have to sell at inopportune time resulting in realization of capital loss.

What is meant by the notion that stock returns "mean revert"? (Reading B, Evaluating and implementing target-date portfolios, Study Guide Module 7, p. 26)

The term mean reversion is often used loosely, and its exact meaning in terms of an assertion about the properties of equity returns through time can be unclear. In general, it is interpreted to mean that if stock returns have been unusually good in the recent past, they are more likely to be poor in the future, while if they are unusually poor in the recent past, they are more likely to be good in the future.

What is meant by the term survivorship bias as it applies to fund performance?(Retirement Plan Investing Essentials, pp. 25-26)

The term refers to the bias resulting from the fact that analyzing a sample of funds at a point in time reflects only those companies that survived, ignoring those that did not. Such a bias can overstate the performance of actively managed fund portfolios.

What is the rationale for the human-capital-based argument holding that equity exposure of TDFs should decline over time? (Reading B, Evaluating and implementing target-date portfolios, Study Guide Module 7, p. 26)

The theoretical human-capital-based argument for decreasing equity exposure over time is based on the premise that, for most people, the value of future earnings and Social Security is an asset with bondlike characteristics, which should be balanced with a significant exposure to stocks. As investors age, the present value of the income they will receive in the future from continuing to work systematically declines, reaching a low level at the point of retirement. Theoretically, to maintain a balanced exposure to market risk through time, this diminishing asset should be gradually replaced with bonds or other fixed income instruments, which share characteristics similar to human capital. Also, younger individuals have far more flexibility to alter their future labor supply in response to bad stock market outcomes, and they have greater flexibility to work more or harder in the future if financial outcomes are poor. As an investor/worker ages, the ability to rely on future work to offset poor outcomes generally declines. This further suggests that as investors approach retirement, they should take on generally lower levels of risk.

What are the three factors that determine portfolio risk? (Retirement Plan Investing Essentials, p. 87)

The three factors that determine portfolio risk are: (1) The variance of each security (2) The covariances between securities (3) The portfolio weights for each security.

An investor purchased a security for $1,000 and sold it six months later for $1,800. During the six-month period, the investor received $200 in cash dividends. What is the investor's total return? (Retirement Plan Investing Essentials, pp. 38-39)

The total return is any cash received plus price changes, divided by the purchase price. In this case, $200 plus $800 is $1,000, and $1,000 divided by the purchase price of $1,000 is 100%.

What are the two basic types of lifecycle funds? (Reading A, An Overview of Lifecycle Funds, Study Guide Module 7, p. 17)

The two basic types of lifecycle funds are: (1) Targeted-maturity funds. These target a specific retirement year and then change their asset allocation from aggressive to conservative as that date approaches. The final allocation is intended to see the investor through retirement. (2) Static-allocation funds. These funds maintain a defined asset allocation. They are typically offered in sets ranging from aggressive to conservative, with the investor determining which portfolio is appropriate for his or her circumstances at any given time.

Describe the two components of return on a typical investment. (Retirement Plan Investing Essentials, pp. 36-37)

The two components of return are yield and capital gain or loss. The yield component is the periodic cash flows from the investment in the form of interest, dividends or other such cash income. The change in value of the asset, either appreciation or depreciation, is called capital gain or loss.

What issues should a plan sponsor address in converting a traditional defined benefit plan to a defined benefit hybrid plan? (Retirement Plans, p. 387)

There are certain issues that a plan sponsor should address in converting a traditional defined benefit plan into a hybrid defined benefit plan. Plan conversions often involve sensitive issues. Since different plans have different rates of accrual or allocation methods, some plan participants will fare better than in the previously offered plan, and other plan participants will see a less favorable situation with the new plan. Employers need to consider: (a) The impact of plan changes on participants (b) Since many plan participants may not be able to determine the impact of plan changes on themselves without assistance from the employer, plan sponsors should consider how to best communicate these impacts and educate plan participants on the specific relevance of plan changes. (c) Regardless of the impact of these changes, employee attitudes toward change and feelings about employer motives are important considerations. Failure on the part of a plan sponsor to adequately plan for and address these issues can result in detrimental effects to workforce morale and productivity loss, as well as costly litigation.

Describe the dual standards a plan sponsor must be concerned with regarding employee benefits communications. (Reading A, Overview of Plan Administration, Study Guide Module 9, p. 22)

There are dual standards to meet in benefits communications. The maximum standards are those the company sets for creating a proper understanding and use of the plans, and the minimum standard is specified by the Employee Retirement Income Security Act (ERISA) for meeting the legal compliance requirements for disclosure to plan participants and beneficiaries. The primary emphasis of Module 9 is in understanding the ERISA requirements for disclosure to plan participants and their beneficiaries.

What is the implication of ERISA fiduciary obligations being more specific and well-defined than those attributable to the Advisers Act? (Reading A, How Are the Fiduciary Duties under the DOL's New Fiduciary Advice Rule Different from the Securities Laws?, Study Guide Module 11, p. 32)

There are important implications of ERISA fiduciary obligations being much more specific and well-defined. ERISA has a specific statutory enumeration of the components of the ERISA fiduciary duty, and there is a well-developed body of case law. In contrast, the Advisers Act itself does not describe substantive fiduciary obligations, nor do the federal courts look to state law for guidance on specific obligations. Existing federal law provides only general guidance as to the substantive parameters of fiduciary obligations under the Advisers Act. Accordingly, the implication for an advisor coming under the more detailed obligations of ERISA subjects that advisor to a more detailed, and more robust, fiduciary requirement and thus increases the risks of litigation for fiduciary breach.

Identify the key times when employers commonly communicate with their employees regarding employee benefits. (Reading A, Effective Benefit Plan Communication, Study Guide Module 10, pp. 27-28)

There are several key times when employers commonly communicate with their employees regarding employee benefit programs. Among these key times are: (a) As new hires at employment (b) As part of the open enrollment communication process (c) As part of the ongoing interaction when employees experience a life event or make routine changes to their benefit programs (d) At the time that the employee terminates employment (e) As a retiree if the employee continues to be eligible for certain benefits.

What are the potential disadvantages of using employer stock as an investment option within a DC plan? (Retirement Plans, p. 552)

There are several potential disadvantages of using employer stock as an investment option within a DC plan. These disadvantages include the following: (a) Employer stock is a completely undiversified investment option and may be inappropriate from a financial perspective. (b) Employer contributions invested in company stock at the employer's direction are not eligible for the Section 404(c) safe harbor provisions. (c) Plan sponsors that permit employee contributions to be invested in company stock must comply with Securities and Exchange Commission (SEC) registration and reporting requirements. (d) Employee relations problems may surface if the value of the employer stock declines. (e) If significant balances are built up in the company stock fund, employees have not only their livelihood but also a sizable block of their savings tied to the well-being of the company. (f) Any investment in employer stock must be shown to satisfy the requirement that plan assets be "expended for the exclusive benefit of employees" and must satisfy the fiduciary requirement for prudence. (g) If employer stock is offered as one of the investment options, the employer must adhere to the PPA diversification requirements. The PPA rules do not apply to employee stock ownership plans (ESOPs).

Does ERISA require that an ERISA-qualified plan have a written investment policy statement (IPS), and how should such a statement be crafted when a plan offers innovative investment products? (Reading B, Prudent Management of Innovative Investments in ERISA Plans, Study Guide Module 10, p. 35)

There has been some contradictory guidance on this issue. Interpretive Bulletin 94-2 allows for, but does not require, a written IPS; yet the court found in Liss v. Smith that the general ERISA fiduciary rules required a written IPS in the circumstances of that case. A written IPS is not required in every case, but it is required in some cases, depending on the facts. Unfortunately, there is little guidance to assist fiduciaries in determining whether, in their specific situation, an IPS is required. An IPS should be written in a way that does not increase the risk of failure by the investment fiduciaries. It should not include any monitoring provisions that would not be followed. A well-crafted IPS should provide guidelines for the investment fiduciaries to properly monitor the innovative investment but should leave some decisions to their judgment. This flexibility will minimize the risk of a breach of fiduciary duty for a failure to follow the terms of the IPS. The investment criteria in the IPS should be written in the context of meeting the needs of the participants. If a strategy is designed to reduce portfolio volatility, then daily, weekly or probably no more than monthly volatility should be monitored and compared to appropriate benchmarks. Not every criterion must be explicit in the IPS, but minutes from the relevant fiduciary committee meetings should reflect a detailed discussion by plan fiduciaries that examined all relevant criteria used to either keep the investment or to liquidate it. Because of the heightened scrutiny as to whether or not an innovative investment was prudent, very detailed minutes and records should be kept from all investment meetings.

What are some of the implications of the key themes enumerated in the previous question, particularly as they relate to retirement plan design? (Retirement Plans, pp. 189-190)

These themes depict a world in which individuals make decisions with incomplete information, are likely to be influenced by the way the decision is presented and make suboptimal choices as a result. Although this model is one of suboptimal choice and inefficiency, it allows for the facilitation of better decision making by framing the decisions differently. The application of behavioral finance is very appropriate in the context of self-directed, defined contribution plan management. With these types of plans, individual participants are faced with the opportunity to make decisions that will enhance their long-term financial security. Essentially, the worker must choose to participate, to set a contribution rate, to select various investments and ultimately to decide how funds are withdrawn from the account. All of these decisions are complex determinations. With the shift from defined benefit plans to defined contribution approaches and, with the elements of defined contribution plan design that place many responsibilities for decision making on the individual participant, the study of behavioral finance and behavioral economics is very relevant to the study and design of retirement plans.

Explain why some sponsors will use index funds as an investment for the core of their portfolio and allow active management of the remaining amount of the assets. (Retirement Plans, p. 455)

This tactic possesses the advantage of freeing the investment managers from having to deal with the core portfolio and, instead, allowing them to focus their time on their specialty areas. Moreover, given a relative sense of security for the core investment, investment managers are able to pursue a higher risk strategy on their subset of the plan's assets in hopes of above-average returns.

Summarize some of the contrary evidence that researchers have found regarding market efficiency. (Retirement Plan Investing Essentials, p. 168)

Though the market appears to generally be highly efficient, there is evidence that this is not always the case. As noted in the prior module, some anomalies exist and may offer opportunities to astute investors. Another example of contrary evidence involves the crash in stock prices that occurred in October of 1987. The Standard & Poor's (S&P) 500 index lost over 20% of its value in a single day. With this occurrence, the question is posed as to whether it is reasonable to argue that investors, efficiently discounting information, decided in one day that the market should be valued at a level that was 20% below the prior day's level. Yet a third example of market inefficiency involves the Internet market bubble that burst in 2000. After climbing to exorbitant heights in 2000, the market significantly declined in value during the two subsequent years.

Which of the two measures of risk is used more often when performing investment analysis and calculations? (Retirement Plan Investing Essentials, p. 52)

Though the two measures, variance and standard deviation, tend to be referenced interchangeably when discussing the concept of variability or risk, the most commonly used measure of dispersion of risk over a period of time is standard deviation. Standard deviation, which measures the deviation of each observation from the arithmetic mean of the observations, is a reliable measure of variability because all the information in a sample is used. Since standard deviation is measured in the same units as the mean, standard deviation is used more commonly than variance when performing investment analysis and calculations.

What are the arguments against international diversification? (Reading A, The Case for International Diversification, Study Guide Module 4, p. 45)

Three key arguments are often mentioned in the case against international diversification. First, it is often argued that the benefits of international diversification are overstated because the markets tend to be more synchronized than suggested previously. Second, skeptics point to the fact that, in recent periods, their domestic markets have generated greater returns than most other markets, and hence that there is no need for international investments in the future. Third, there are numerous potential barriers to international investing.

Describe the changes made by PPA in terms of the content requirements for the personal benefits statement for retirement plans. (Retirement Plans, p. 506)

Traditionally, plan participants and beneficiaries could request in writing a statement of their own benefits, but not more often than once in any 12-month period. The statement would include the total benefits accrued and the portion, if any, that was vested or, if benefits were not vested, the earliest date on which they would become vested. While still retaining the right to request a benefit statement within any 12-month period, PPA expanded issuance requirements as described in Learning Objective 2.2. Additionally, PPA added a number of substantive requirements for the content of personal benefit statements. If a participant can direct plan investments, the benefit statement must provide the following: (a) Information explaining any restrictions on the right to direct investments (b) An explanation on the importance of diversifying investments (c) A statement cautioning participants on the risk of holding more than 20% of a portfolio in the securities of any single entity, such as employer securities. For a defined benefit plan, the benefit statement must include: An explanation of any permitted disparity under Section 401(l) or of a floor-offset arrangement.

Describe two key events that have occurred and their implication in quelling the controversy that has accompanied plan conversions from traditional defined benefit plans to hybrid retirement plans. (Retirement Plans, p. 389)

Two key events have occurred that should serve to quell the controversy accompanying plan conversions from traditional defined benefit plans to various types of hybrid plans. As previously indicated, passage of PPA contained various clarifications related to age discrimination in hybrid plans. PPA amended the Internal Revenue Code (IRC), ERISA and the Age Discrimination in Employment Act (ADEA) to provide that defined benefit plans are not age-discriminatory if, as of any date, a participant's accrued benefit is at least equal to the accrued benefit of any similarly situated, younger individual. Accordingly, cash balance plans are not age-discriminatory as long as pay and annual interest credits for older workers are not less than pay and annual interest credits for younger workers. (Note that this provision does not apply unless interest credits are not greater than a market rate of return, and cumulative interest credits are not negative.) The second key event was the decision by an appellate court in the case of Cooper v. IBM. The appellate court reversed a lower court ruling on the issue of "accrued benefits" and determined that cash balance plans generally are and always have been legal.

What does the Uniform Prudent Investor Act (UPIA) opine on restrictions concerning the exclusion of certain prohibited investments from a portfolio, and how is this issue comparably referenced in ERISA Section 404(a)? (Reading B, Prudent Management of Innovative Investments in ERISA Plans, Study Guide Module 10, p. 30)

UPIA is clear that there exists no such prohibitions on specific types of investments. UPIA states, "All categorical restrictions on types of investments have been abrogated; the trustee can invest in anything that plays an appropriate role in achieving the risk/return objectives of the trust and that meets the other requirements of prudent investing. A trustee's investment and management decisions respecting individual assets must be evaluated not in isolation but in the context of the trust portfolio as a whole and as part of an overall investment strategy having risk and return objectives reasonably suited to the trust." Similarly, the language of ERISA Section 404(a) requires a fiduciary to discharge his or her duties under the "circumstances then prevailing that a prudent man acting in like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims." This language takes into account the needs of participants and allows for changing investment strategies over time as the "circumstances then prevailing" change.

How are a plan sponsor's contributions determined under a target benefit plan? (Retirement Plans, pp. 389-390)

Under a target benefit plan, a plan sponsor's required contributions are determined actuarially in order to meet income replacement targets established in the plan at inception, which are expressed in terms of a percentage of salary near the time of retirement. Once an initial contribution formula is established, subsequent adjustments to actuarial assumptions are not made. Despite having actuarially determined contributions, target benefit plans are defined contribution plans because the targets are not guaranteed, and individual participant account values reflect the actual gains and losses from investments. Most often target benefit plans allow participants to direct investments within their accounts. When comparing the target benefit plan to other types of plans, certain observations can be made. The exact benefit under a target benefit plan is less certain than the benefit in a traditional defined benefit plan. However, contributions in target benefit plans tend to be more certain than in typical profit-sharing plans. Another observation is that contributions tend to be heavily weighted by age to favor older participants in target benefit plans.

What must a plan sponsor do to fulfill its obligations relative to joint and survivor notifications? (Retirement Plans, p. 508)

Under defined benefit pension plans and some defined contribution plans, each participant must be informed, individually and in writing, of the right to elect or reject both pre- and postretirement survivor benefits. Timing for notification as to postretirement survivor benefits is nine months before the earliest retirement date under the plan. Notification for preretirement survivor benefits must be provided between the first day of the plan year in which the participant becomes the age of 32 and the end of the plan year in which he or she becomes the age of 35. If an employee is over the age of 32 when hired, notification must be provided within three years after that employee becomes a plan participant. If a vested participant terminates employment before the age of 32, notice must be provided within one year after the termination date. The notifications must include enough information about the potential financial impact on the individual's own benefit for the participant to make an informed decision. Contents of the notification are specified by regulations.

Describe the two approaches used in transition from stocks to bonds in a targeted-maturity fund. (Reading A, An Overview of Lifecycle Funds, Study Guide Module 7, p. 20)

Under the approach called glide path, incremental changes are prescribed from the start. The asset allocation does not vary; it is known in advance for any point in the transition toward the target date. Under the approach called tactical, there is systematic market timing to determine when allocation changes will occur. Under this approach, the asset allocation path is not prescribed; it will vary with the manager's assessment of financial market conditions and the relative valuations for various asset classes.

Under the law, what responsibilities does a fiduciary possess? (Retirement Plans, p.511)

Under the law, a fiduciary possesses several responsibilities. A fiduciary is required to discharge all duties solely in the interest of participants and beneficiaries and for the exclusive purpose of providing plan benefits and defraying reasonable administrative expenses. In addition, a fiduciary is charged with using the care, skill, prudence and diligence that a prudent person who is familiar with such matters would use under the circumstances then prevailing—a standard that has come to be called the prudent expert rule. A fiduciary also is responsible for diversifying investments so as to minimize the risk of large losses, unless it is clearly prudent not to diversify. Finally, the fiduciary must conform with the documents governing the plan and must invest only in assets subject to the jurisdiction of U.S. courts. This latter requirement does not preclude investing in international securities; it simply requires that the assets be held in a manner such that they are subject to the jurisdiction of U.S. courts.

What are the benefits of customized TDFs? (Reading B, Evaluating and implementing target-date portfolios, Study Guide Module 7, pp. 36-37)

Unlike the packaged products, plan sponsors that select the customized approach can create funds they deem to be the best fit for their participants. For example, customization offers plan sponsors the ability to create their idea of an "optimal-solution" TDF. Another reason for customization might be that a plan sponsor may want the same manager that runs the company's defined benefit plan to run its defined contribution plan. Customization also includes altering stock/bond/cash allocations to fit what plan sponsors and investment committees deem to be a more appropriate level of risk exposure for participants. Plan sponsors considering customization need to know what is different about their participant population.

Describe the impact of adopting TDFs on participant portfolios. (Reading B, Evaluating and implementing target-date portfolios, Study Guide Module 7, p. 41)

Using TDFs as a default option or mapping participants from static-allocation lifecycle or other funds accelerates adoption of these funds. Introducing TDFs on a voluntary basis is expected to gradually increase adoption rates through new plan entrants and among younger, less affluent and/or female participants. Ultimately, it is believed that TDFs can produce changes in participant portfolios that are consistent with the objectives of many plan sponsors, including more suitable risk levels and diversification, which should enhance participants' prospects for achieving financial security. However, studies show that not all participants use TDFs as their "complete solution" for retirement investing. Thus, features such as transparency of TDFs and simplicity of implementation may add value by allowing participants to take advantage of the basic TDF structure while supplementing their portfolio with individually chosen modifications. For some sponsors, adopting TDFs that all investors can easily use as the core of a retirement portfolio will be preferable to adopting a suite of TDFs that participants can't easily identify or understand. Complex or constantly changing structures may lead those participants who "pop the hood" to conclude that they are better off using the TDF fund as their only holding, or not at all.

How does the use of service providers alter the legal liabilities of the plan administrator? (Retirement Plans, p. 536)

Using various service providers generally does not change the fact that the company remains the plan administrator for the legal purposes of the plan document. The company is responsible for the actions of these service providers, so it is important that the company makes the selection carefully and monitors how the services are provided. The first step is to determine what elements should be performed by internal staff and which are better completed by external providers. Depending on the size and nature of a company or organization, certain functions may be completed more easily by the plan sponsor. Over time, the particular mix of who is responsible for which pieces of the plan administration may change.

What is wealth mgmt? (Retirement Plans, pp. 564-565)

Wealth management is a process for managing resources that seeks to meet an individual's needs and achieve his or her objectives by integrating a diverse range of services. Typically, the process of wealth management utilizes a comprehensive approach involving investment management, financial planning, retirement planning, estate planning, tax planning, asset protection, risk management, and cash flow and debt management. As such, retirement planning necessitates being placed in this overall wealth management context. If conducted effectively and executed successfully, wealth management retirement planning should result in greater asset accumulation, less overall financial risk, reductions in tax liabilities, cost reductions related to the management of resources, and efficiencies in managing cash flow and reducing debt.

What must a plan administrator do when a distribution from a qualified plan is eligible to be rolled over into an individual retirement account (IRA) or another employer's qualified plan? (Retirement Plans, pp. 508-509)

When a distribution from a qualified plan is eligible to be rolled over into an IRA or another employer's qualified plan, the plan administrator, within a reasonable period of time before making the distribution, must send a rollover notification to the participant or beneficiary explaining the rollover and direct transfer rules, the tax-withholding requirements on distributions that are not directly transferred, and how taxes can be reduced or deferred (e.g., rollover). In general, the timing of the notice must meet the same requirements that apply to notifying participants of their rights as to the qualified joint and survivor annuity rules under a defined benefit plan. The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) expanded notice requirements for eligible rollover distributions by requiring that the written explanation provided to recipients of eligible plan rollover distributions include a discussion of the potential restrictions and tax consequences that may apply to distributions from the new plan to which the distribution is rolled over that are different from those applicable to the distributing plan. EGTRRA also made a direct rollover the default option for involuntary distributions that exceed $1,000 when the qualified retirement plan provides that nonforfeitable accrued benefits that do not exceed $5,000 must be distributed immediately.

What decision elements must be considered when accumulating and distributing wealth to support retirement income needs? (Retirement Plans, pp. 569-570)

When accumulating and distributing wealth to support retirement income needs, decisions must be made concerning the following issues: (a) Developing the retirement resource target (b) Assessing the efficiencies of funding structures (c) Examining the funding structures in relation to other factors, participant needs or the broader environment (d) Implementing investment selection, risk management and strategic allocation of resources within the retirement saving structures and monitoring the impact of these decisions on an overall portfolio of wealth (e) Considering distribution planning and execution (f) Monitoring excesses or deficiencies relative to retirement income needs (g) Disposing of excesses or deficiencies when retirement income is no longer needed.

Summarize how the condition of choice overload can impact retirement choices. (Retirement Plans, p. 192)

When individuals approach this complicated decision, many times they are faced with a large and perplexing set of alternative choices. The decision is complicated enough, but the innumerable different possible scenarios and the proliferation of options within retirement planning structures expand the possible choices that individuals may select. The sheer volume of choices, or choice overload, often serves to result in a "paralysis of analysis" and an inability to settle on a decisive course of action.

What are the tax efficiencies of ETFs over index mutual funds? (Retirement Plan Investing Essentials, p. 21)

When investors sell their mutual fund shares back to the company, the fund may have to sell securities to purchase the shares. If enough redemptions occur, the mutual fund could generate a capital gains liability for the remaining shareholders. In contrast, ETF redemptions do not involve the ETF fund at all but, rather, one investor selling to another. The ETF manager does not have to sell shares to pay for redemptions; therefore, ETFs avoid redemptions and the capital gains that could result from this activity.

Do investors seem to make effective decisions when it comes to disposing of assets rather than when initially choosing to purchase them? (Retirement Plans, p. 194)

When it comes to selling or disposing of assets, individuals have biases against selling assets at a loss. They often liquidate assets that have appreciated and retain investments where the market price has declined. This disposition effect does not mean that investors are rationally evaluating assets in terms of their long-term intrinsic value. Rather, many investors appear to be avoiding the regret they would experience in recognizing a loss. These investors show a propensity to hold onto some marginal or inferior investments while disposing of the more superior investments.

In general terms, what issues must be considered by plan sponsors when two companies sponsoring defined contribution plans decide to merge operations? (Retirement Plans, p. 542)

When two companies sponsoring defined contribution plans decide to merge, several issues must be considered and must be addressed early in the merger process. A primary decision must be made—whether the two plans will be combined or whether both plans will continue to be maintained separately. While it may be easier initially to maintain two plans, in the long term this generally is feasible only if there will be an overall separation of the two workforces rather than the creation of an integrated company. If the decision is made to maintain two separate plans, it will be necessary to make sure that both plans properly address the treatment of employees who transfer between the two divisions, ensuring that the plans give credit for service with either company for vesting purposes. The plans also need to specify which employees are considered participants in which plans, and whether a participant who transfers between the divisions can transfer his or her account from one plan to the other.

What are the limitations of customized TDFs? (Reading B, Evaluating and implementing target-date portfolios, Study Guide Module 7, p. 37)

While packaged solutions offer a stable, straightforward structure, making it easier for those who want to marginally adjust their portfolios to do so, the inherent lack of transparency of customized TDFs makes participant adjustments difficult. Another limitation is that customized TDFs generally are not transferable in the event of a job change or other life event. Also, they are cost-prohibitive for small plans.

How do policies and procedures work in conjunction with a plan document in the operation of a retirement plan? (Retirement Plans, p. 533)

While the plan document provides the formal legal structure and general operating policies of the plan, numerous other procedural elements require more in-depth plan features that need to be addressed that are not detailed in the plan document. A well-managed plan will have a set of policies and procedures that guide the daily operation of the plan. There are some policies that every plan should have and that should be formally prepared, reviewed and maintained. These include an investment policy; policies regarding participant loans and hardship distributions, if applicable; and a policy regarding qualified domestic relations orders (QDROs). Some of these policies, such as the investment policy, can be anticipated at the plan's inception and should be in place at the start of plan operations. Other policies may be determined when a question or unique situation arises.

How have doubts about the value of international investing been addressed? (Reading A, The Case for International Diversification, Study Guide Module 4, pp. 54-56)

While there is still some evidence that the international correlation of equity markets increases in periods of market distress, the evidence is not as strong as suggested by some practitioners. The pitfall in estimating correlations during volatile periods is that correlations conditioned on part of a sample are biased. The apparent observation that correlation increases in periods of market turbulence can simply be an observation that market turbulence has increased, but the true correlation has remained constant. Also, it is true that economies and markets are becoming increasingly integrated, and business cycles are increasingly synchronized as corporations pursue global strategies. Yet there still exist vast regional and national differences. To take the late 1990s as an example, most of Asia was in a prolonged recession while the United States was booming. Even within the European Union, the economic performance differs widely among countries. The three leading economies, France, Germany and the United Kingdom, demonstrated big differences in the timing and intensity of their economic growth. Finally, the traditional approach to international diversification has been based on the premise that country factors are the dominant factors affecting all stocks of a country. With increased globalization, industry factors are growing in importance, while country factors see their influence reduced. As the industry factors dominate, global investing refers to investing in the best companies, wherever they are located in the world, and to recognizing that these companies will also be investing worldwide.

What are the pros and cons of using a packaged product for TDFs? (Reading B, Evaluating and implementing target-date portfolios, Study Guide Module 7, pp. 35-36)

With a packaged solution, a TDF is constructed for the typical participant with a moderate risk tolerance. The advantages of packaged solutions are that they can be cost-efficient and also can potentially offer some portability. With packaged solutions, participants with the same target-retirement year get the same portfolio, which means the asset allocation mix and other fund characteristics are the same for everyone at a given point on the glide path. Two perceived problems with this structure are: (1) Not everyone with the same target date shares the same investment goals and risk tolerance, and (2) participants at one company do not necessarily share the same demographics as participants at another company. These issues have led to the creation of customized solutions in which plan sponsors create funds they deem to be the best fit for their participants.

Discuss the concept of savings anchors and how they can adversely impact decisions regarding the appropriate amounts to save for retirement. (Retirement Plans, p. 193)

Workers are deciding the appropriate level at which to save for retirement. This decision has enormous implications as to whether they will have sufficient resources to fund a comfortable retirement. Savings decisions are subject to certain biases, and anchors involve an initial starting point or level from which the decision maker adjusts. When one examines the level at which individuals save for retirement, one can identify the starting points from which individuals begin their decision process. Researchers have noted that so-called savings anchors vary with age and income. Those who are closer to retirement and possess higher incomes appear to anchor their savings to the maximum allowed under the law. Conversely, workers who are further from retirement and possess lower incomes tend to anchor their savings to the minimum level of contribution necessary to receive the full employer match. In both of these situations, it appears that the level of saving is affected more by the anchor and perhaps by affordability than by a computation of the necessary funds to sustain a certain income level during the retirement years.

Use the following figures to calculate the cumulative wealth index for the period 2014-2018 for $1 invested at the end of 2013. (Retirement Plan Investing Essentials, pp. 41-42)

Year Total Return(%) 2014 10 2015 8 2016 5 2017 -12 2018 20 The calculation would be as follows: 1.00(1.10)(1.08)(1.05)(.88)(1.20) =

In converting from a traditional defined benefit plan to a hybrid defined benefit plan, are there approaches that companies can use to allow employees to avoid the adverse effects of plan conversion? Explain. (Retirement Plans, p. 388)

Yes. There are approaches companies can use when converting from a traditional defined benefit plan to a hybrid defined benefit plan that allow employees to avoid adverse effects of plan conversion. Some of these approaches would include the following: (a) Allowing all employees to choose between the old plan and the new plan (b) Allowing employees whose benefits are adversely affected by the conversion the choice to remain in the old plan (c) Making an adjustment to initial account balances of the new plan for adversely affected employees (d) Making additional contributions to other plans sponsored by the employer and within which the adversely affected employees are participating.

What was the total return to the U.S. investor after the appropriate currency adjustment? (Retirement Plan Investing Essentials, p. 44—Example 2-6)

[1.20 X .70/.80] -1.0=.0500 or 5.0%

Does a retirement plan that permits participant-directed investments need an

investment policy? Explain. (Retirement Plans, p. 534) An investment policy is needed for every type of plan, including a plan that permits participants to direct the investments in their own accounts. The investment policy is the written document outlining the guidelines for the structure, operation and decision making for the investments held by the retirement plan. The investment policy would include such things as the selection criteria for the investment managers or mutual funds offered in the plan, the benchmarks that will be used to measure the performance of the investments, the process and criteria used to change an investment or fund offering, the frequency with which the investments will be reviewed (quarterly or annually) and how the investment fees are to be paid. If the plan investments are not participant-directed, then the policy should include the targeted asset allocation and the frequency of rebalancing. If the investments are participant-directed, the policy should include the number of fund options permitted, the range of investment options allowed and the default investment option. It also is important to specify whether any restrictions exist on certain types of investments, such as establishing that no investments are permitted in hedge funds or in mutual funds that have a front-end load.

Are procrastination and inertia factors in impeding individual participant action when it comes to retirement planning? (Retirement Plans, p. 191)

Yes. Procrastination and inertia are factors that impede individual participant action when it comes to retirement planning. Individuals have a tendency to delay making decisions and have difficulty once they delay a decision to take action to change their course or direction. Inactivity in decision making tends to have a "stickiness" that demands more effort to overcome once a decision is delayed, deferred or avoided. Procrastination may result from a bias toward the status quo that is described in the next question. At times, a decision to maintain the status quo may make rational sense, but at other times, particularly when the cost of a delayed decision is high, the preferential bias toward the status quo is clearly irrational. For instance, when an employee is willing to forgo an employer match in a 401(k) plan, procrastination and inertia are clearly irrational.