FIDUCIARY INSIGHT · FOR PLAN SPONSORS
The 401(k) Problem Nobody Is Talking About
Most plans are compliant, competitively priced, and quietly unable to protect the people they were built for. Here is what the committee is not being shown — and what a plan looks like when it is built to survive a bad year.
By Dominick Paoloni, CIMA® — Founder and Chief Investment Officer, IPS Strategic Capital
Every 401(k) review I have been handed in more than three decades begins in the same two places. What does the plan cost, and how did the funds do against their benchmarks. Both are fair questions. Both get answered in a quarterly deck full of green arrows. And a plan can pass both tests cleanly while carrying a risk that nobody in the room has ever measured.
Here is the part nobody says out loud. A 401(k) menu is not a portfolio. It is a list. The committee approves the list. The participant builds a portfolio out of it. And no one ever checks whether the list makes a survivable portfolio possible in the first place.
Five things follow from that. The first four are the problem. The fifth is what to do about it.
One — eight funds, one decision
Open a plan lineup and count the US large-cap options. In the plans we review it is routinely six, seven, eight. Growth, value, blend, a contrarian one, an index one, and one or two more added years ago that nobody has questioned since.
That is not eight decisions. It is one decision, sold eight times.
Diversification in most plans is measured by fund count. It should be measured by what the funds do when it matters. In one plan I reviewed recently — two dozen options outside the target-date series, a well-run committee, fees at market — exactly two finished 2022 in positive territory. Two, out of twenty-four. Everything else was a passenger on the same plane.
And inside the US large-cap sleeve alone, the gap between the best and the worst fund that year ran past thirty percentage points. Same asset class, same label on the fact sheet, and a thirty-point difference in what a participant actually lost — decided entirely by which of eight names they happened to pick on their first day, in the four minutes between filling out a W-4 and finding the break room.
Two — the glide path is an opinion, and it changes after the loss
Roughly seven in ten participants hold a target-date fund (EBRI/ICI data, year-end 2023). Among plans that automatically enroll, the GAO found target-date funds to be by far the most popular qualified default investment alternative — which means that is where the money goes when an employee makes no choice at all.
So it is worth knowing what that fund actually is. It is one asset manager’s opinion about how much risk a stranger your age should be carrying, and the industry does not agree with itself. In its own review of registration statements the SEC found, in 2010, equity exposure at the target date ranging from roughly 25% to 65% across target-date funds generally. In its 2011 review the GAO found one fund at about 65% equity at its target date and another at about 33%. The Department of Labor’s guidance to plan fiduciaries says it plainly: there are considerable differences among target-date funds from different providers, even among funds with the same target date.
It gets more specific. In 2008, funds dated 2010 — money for people about two years from retiring — lost nearly 24% on average, with a range from about 9% to 41%. That is the SEC staff’s own analysis. One target year, a thirty-two point spread in outcome, and no participant chose that spread.
Then look at what happened next. One widely held 2025-dated fund reported 5.7% in bond funds at the close of its 2008 fiscal year. As of mid-2026 the same fund holds roughly 48% bonds. The participant did not change their mind about risk. The fund changed its mind — after the loss.
That is not a scandal. It is how the industry works. The glide path gets revised when the evidence arrives, and the evidence arrives as somebody’s lost decade.
Three — the diversifier that stopped diversifying
This is the one almost nobody raises in a committee meeting, and it is the one that matters most.
The whole architecture of a retirement menu rests on a single assumption: when stocks fall, bonds will hold. That is what “balanced” means. It is what the glide path is for. It is the reason the closer a participant gets to retirement, the more of their money sits in fixed income.
For most of the last forty years the assumption held, and in 2008 it held beautifully. US equity fell about 37% and investment-grade bonds returned about 5%. A participant with half their money in bonds lost far less than the market did — exactly as designed.
In 2022 it did not hold. US equity fell about 19.5% and the same investment-grade bond index fell about 13%. Long Treasuries — the longest-duration, supposedly safest end of the market — fell more than 30%. The only cushion was cash, and there was very little of it. The thing that rescued people in one crisis was a second source of loss in the next.
This is what covariance means, without the math: the question is not how many things you own, it is whether they stay unlike each other when you need them to. Correlations are not constants. They converge under stress, and they converge precisely when convergence costs the most.
And the dollars are worst exactly where the glide path claims to be safest, because the balance is largest there.
A 60-year-old with $1.5 million in a dated default fund lost roughly $190,000 in 2022. A 30-year-old with $80,000 in a broad US equity fund lost roughly $15,600. The older employee’s fund fell less in percentage terms — and still cost more than twelve times the money. Illustrative example only. Assumes a 2022 return of −12.7% on the dated default fund and −19.5% on a broad US equity fund. Balances are hypothetical and do not represent any actual participant account. |
Sequence-of-returns risk is not removed by a glide path. It is concentrated by it, because the biggest balance sits in the allocation with the least room to recover.
Meanwhile the things that did work in 2022 are the ones a plan menu almost never offers. Trend-following finished the year sharply higher — the SG Trend Index gained 27.3%. Broad commodities rose. Gold ended the year roughly flat while both equities and bonds fell by double digits, which in that particular year was its own kind of success. Almost no plan lets a participant hold any of them in meaningful size. The fire extinguisher was in a locked cabinet.
One year proves nothing on its own, and it would be dishonest to pretend otherwise — trend-following and commodities have had long stretches of flat and negative returns, including in the years right after 2022. No asset class works in every environment. That is precisely the argument for covering more than four of them.
Four — and you are paying for the privilege
Cost is the one thing committees reliably do look at, and it is still usually read wrong.
The average 401(k) participant in a target-date mutual fund paid 0.27% in 2025 (ICI). That is genuinely cheap, and it is the number everyone quotes. The trouble is that it is an average, and the dispersion behind it is enormous. The GAO, citing a 2010 industry analysis, found asset-weighted target-date expense ratios running from 0.19% to 1.71% — the dearest about nine times the cheapest (GAO-11-118).
Worse, the dispersion exists inside a single fund. The same target-date portfolio, run by the same managers, holding the same securities, is sold in share classes that differ by more than three times.
A plan holding the R-3 class rather than R-6 pays 0.95% for a portfolio available at 0.31%. Nothing about the investment changes. The difference pays for distribution. Share-class eligibility varies by plan size and platform, and in some arrangements the spread offsets recordkeeping costs the plan would otherwise pay directly — which is worth asking about, in writing.
At the plan level the same pattern repeats: ICI/ISS Market Intelligence data for the 2022 plan year put all-in cost for a $10–50 million plan at 0.82% on average and 0.65% at the median. Compounded across a working life, that gap is not a rounding error.
Five — the duty to monitor never ends, and it is yours
This part belongs to you personally rather than to your employees.
Under Tibble v. Edison, 575 U.S. 523 (2015), a fiduciary’s duty to monitor plan investments is continuing — separate from, and in addition to, the duty to select them prudently in the first place. It does not reset when the lineup is chosen. It does not expire.
Which is why a lineup that has not been benchmarked in years is a documentation gap worth closing now, in this market, rather than after something goes wrong. A crash does not create that gap. It reveals it. We are not a law firm — your ERISA counsel is the right person to size the risk for your plan.
Most CFOs I meet have a thick binder proving the plan’s fees were reviewed. Very few have a single document showing that anyone ever tested whether the lineup could hold together in a bad year. That document is cheap to produce and uncomfortable to be without.
What a plan built to survive a bad year looks like
It is not more funds. Adding a ninth large-cap manager does nothing.
It is a menu assembled so that a reasonable participant can build a portfolio whose pieces do not all fail at once — and proved against real history rather than a risk questionnaire. Start with what a typical menu actually covers.
WHAT DRIVES RETURNS | IN THE PLANS WE REVIEW |
US equity | Yes — often six or eight times over |
International equity | Yes |
Investment-grade bonds | Yes |
Cash or stable value | Yes |
Inflation and broad commodities | Rarely, and almost never in size |
Trend-following and managed futures | Almost never |
Gold | Almost never |
Defined-outcome or hedged equity | Almost never |
Four risk drivers covered, most of them several times over. Four barely there or absent altogether. That is the problem in one table, and it is a menu-design problem rather than a fund-selection problem — no amount of manager research fixes it.
Three things change it:
• Fewer, better-chosen options spanning genuinely different risk drivers. Low-cost index exposure at the core, with real diversifiers beside it — not eight versions of the same bet.
• A default that is stress-tested, not just glide-pathed. If it has never been run through 2008, 2020 and 2022 as a portfolio, it has not been tested.
• A written record. Every option benchmarked on cost, behaviour and redundancy, reviewed on a calendar rather than after a headline.
And one point worth settling, because it surfaces in every committee meeting: the obstacles people believe are in the way mostly are not there. Several of these exposures are available as institutional mutual funds or collective investment trusts: daily valued, payroll-friendly, and perfectly workable on a recordkeeping platform, though availability, structure and cost vary by exposure, recordkeeper and plan size. Where a plan offers a self-directed brokerage window, participants can already hold individual securities and, where the plan document permits, listed options — though a window carries its own fiduciary considerations, the Department of Labor has issued no formal safe harbour for one, and committees typically set eligibility rules, a cap on the share of a balance, an education requirement, and a process for selecting and monitoring the window provider.
As for options, the binding constraint is narrower than people think. An account inside a qualified plan cannot trade on margin, which rules out naked selling, collateral-posting spreads and most premium-harvesting programmes. It does not rule out buying protection. IPS buys options as insurance; the firm does not sell premium to manufacture income. Whether any of it is permitted in a given plan depends on the plan document, the recordkeeper and the brokerage provider — which is a question for your ERISA counsel, not for us.
Diversify for growth. Hedge for protection. Those are two different jobs, and for more than three decades our industry has asked one tool to do both. Diversification remains a fiduciary requirement and the right place to start; it simply is not, by itself, a plan for a bad year. A hedge is a contract: the cost and the term are known at the outset and the payoff follows a formula agreed in advance, provided the position is held as designed — and it can expire worthless. Diversification is a hope.
Why IPS Strategic Capital
IPS Strategic Capital is a fee-only, founder-owned registered investment adviser, founded in 1993 and headquartered in Lakewood, Colorado. We are a hedging firm before we are anything else — we build downside-management solutions for institutions, advisors and families, and we buy options as insurance rather than selling premium to manufacture income.
For a plan, we serve as your ERISA §3(38) investment manager. The distinction is worth being precise about. A §3(21) adviser recommends, and your committee still decides and still owns the investment decision. A §3(38) manager decides and implements, and responsibility for investment selection shifts to the appointed manager, subject to your plan document and your ERISA counsel’s review. Your committee’s job narrows to prudently selecting and monitoring that manager. It does not disappear — nobody can honestly tell you it does — but it becomes far smaller and far easier to document.
Then there is what else is included in the engagement. Every employee in your plan gets the full IPS service set at no additional cost:
• Financial and retirement planning with a named advisor — at every balance level, not just the large ones
• Estate planning, with wills and trusts drafted by independent partner attorneys — IPS does not practice law
• Tax-aware planning and real estate evaluation
• Concentrated-stock and equity-compensation strategy for the executives who need it
• Plain-English group education sessions for your staff
These are included in the engagement at no additional charge to the company or to participants beyond the plan’s stated investment-management fee, subject to the terms of the engagement; scope and availability vary. When you work with IPS, customer service is not a department. It is an attitude.
One question
Before you renew anything, ask whoever advises your plan today a single question:
“What is our plan for when the market drops 30%?” |
If the answer is “stay the course,” that is a hope, not a plan — and hope is not a fiduciary process.
We will run your plan’s lineup through 2008, 2020 and 2022 and put the result in writing, board-ready, at no cost and no obligation — so the committee knows its number either way. Where a fund’s own history does not reach that far we use its predecessor share class or an index proxy, and the report says exactly where.
Dominick Paoloni, CIMA® is the founder and Chief Investment Officer of IPS Strategic Capital in Lakewood, Colorado. He earned his CIMA® through the Wharton School, teaches finance as an adjunct professor at the University of Denver and the University of Colorado, and was recognized in Morningstar Advisor Magazine in 2009 for protecting client portfolios through the 2008 credit crisis. He is co-author of the white paper “Hedging vs. Diversification,” hosted on Cboe’s site.
215 S. Wadsworth Blvd., Suite 540, Lakewood, CO 80226 · 303.697.3174 · investps.com
This material is for informational purposes only and is not an offer to buy or sell securities, nor personalized investment advice. Investing involves risk, including possible loss of principal. Options involve risk and are not suitable for all investors. Past performance is not indicative of future results. Index returns are shown for asset-class illustration; indices are unmanaged and cannot be invested in directly. Defined-outcome structures have terms, costs, and conditions that determine results. Plan data referenced has been anonymized and examples are illustrative only. IPS Strategic Capital is a registered investment adviser; registration does not imply a certain level of skill or training. IPS is not a law firm or an accounting firm — consult your ERISA counsel and tax advisor regarding your plan.
