Does your 401 (k) have to be “tailor-made”?
The term “made to measure” has long been associated with the best products. But bespoke products aren’t limited to cars, clothing, and furniture. In fact, 7% of 401 (k) plan participants on Vanguard’s platform have their 401 (k) asset allocation tailored to their individual needs using an advisory tool commonly known as an account. managed (MA).
Under a managed accounts program, a plan sponsor chooses a third-party advisor to provide independent investment advice to participants. Some plans offer a choice of providers, but many only offer one product.
Participants who sign up for the service are encouraged to provide the advisor with additional information, such as their risk tolerance, assets outside of their 401 (k) plan, and expected retirement date. Using this information, the provider will develop the participant’s overall asset allocation, choose investments, and monitor and rebalance accounts, all on an ongoing basis. In fact, participants entrust the discretion of the management of their entire defined contribution plan account to a professional third party.
In addition to asset management, many providers offer additional advice on savings levels, when to start collecting Social Security payments, and designing a sustainable retirement disbursement strategy. But the delegation of asset allocation and fund selection of a participant’s balance is at the heart of the service.
Fees vary widely, but are generally assessed as a percentage of assets and can range from 20 to 75 basis points. And while that may not seem substantial, it can add up to a considerable amount over an extended period of time. For example, if you put $ 10,000 per year in a 401 (k) plan over a 30-year career with a 6% return, there is an additional charge of 30 basis points – on top of the investment fee. underlying plan funds – will cost around $ 50,000 over the period.
Things to consider before choosing a managed account
Most of the literature on this topic available in your plan highlights the various benefits of using a managed account … with generally less emphasis on its limits, other than the standard disclosure that any investment involves risk. .
So, for those participants who want help with asset allocation, how do you determine if the added cost of a managed account is worth it, especially compared to Target Date Funds (TDFs)? Target date funds are prepackaged, age-appropriate investment strategies designed to provide post-employment income while reducing risk as retirement approaches. In other words, which solution (net of costs) will produce the best result?
As with any investment decision, there are many factors to consider, but here are a few considerations that typically don’t show up in marketing materials:
Accurate benchmarking of performance is not possible
One of the limitations inherent in managed accounts is that there is no widely accepted way to assess the return on your investments. Most investment funds are compared to a benchmark, an index of unmanaged securities against which the fund’s performance can be measured. Because each asset allocation for managed account users is personalized to the individual, there is no agreed way to measure performance against if you had invested in a target date fund.
The investment funds available for your MA portfolio are limited
When building a personalized investment portfolio, managed accounts are limited to using only the investment funds available in the plan. There are small plans where an advisor can choose funds to be used specifically as part of an advisory product, but this option is generally not available to anyone working for medium or larger employers. This can make it more difficult for managed accounts to achieve similar performance to target date funds that do not have this limitation. (To be fair, managed account providers are looking at the fund ranges and, if additional asset classes are needed, will ask the plan sponsor and / or their consultant to consider fund additions.)
Your portfolio might look like a typical target date fund anyway.
Suppliers often point out that they create a unique portfolio for you based on your individual situation. As cited in a Government Accountability Office (GAO) report, building a unique portfolio relies on both personalization and personalization. Personalization involves assigning a participant’s account only based on age or other factors that can be easily obtained from the plan records manager, such as gender, income, checking account balance and the current savings rate. These can be obtained without commitment from the participants.
Many suppliers also personalize asset allocation based on factors such as external departures, including balances from other pension plans, risk tolerance, expected retirement age and spouse’s assets. But unfortunately, the track record of participants who use this service is decidedly mixed when it comes to capturing and maintaining their personalized information.
While many providers issue, at a minimum, quarterly reminders in addition to other awareness initiatives, GAO reported that typically less than a third, and sometimes less than 15%, of participants provide this personalized information. If this surprises you, think about your personal finances and ask yourself if you paid any recurring charges (for example, a service contract or a streaming service) for a product long after your last use.
So what if you don’t customize? In these cases, providers need to make assumptions based on your age and the personalized data they get from your case manager. And those assumptions may not differ significantly from those made by your plan’s target date manager for members of your age cohort.
Simply put, you can pay for a bespoke product but end up getting the equivalent of a target date fund but at a higher cost.
Steps to take before investing
What actions can you take to resolve the above issues? Here are some ideas:
Do a self-assessment
As pointed out above, managed accounts are much less valuable if you don’t provide and maintain your personalized financial information. So, first of all, you should do an honest self-assessment of your long-term willingness to spend the time necessary to maintain the necessary information. For example, if you are the type of person who ignores benefit choices and doesn’t even bother to take a look at plan documents, you might not be well suited for this type of service. .
Ask the supplier
Contact the managed account provider before investing and ask questions about how to assess performance and the degree of customization you can expect based on your personal financial situation. Challenge them to prove why their option is greater than your plan’s target date fund.
Use the product for a limited time
Managed account services can be terminated at will. So one approach might be to sign up for the service, look at the asset mix and see how it differs from the age-appropriate target date fund. Then you can get a better idea of the degree of personalization provided and end the service if you don’t think it is useful. Many providers will offer windows of 60 to 90 days during which you can enjoy the service for free. Just make sure you “watch the clock” and don’t let it renew automatically (like those streaming service subscriptions).
Older participants can evaluate alternatives outside of the plan
One of the inherent limitations of managed accounts offered through a qualified plan is that you usually only have a choice of one or two vendors, as archive managers want to limit the expense of creating the required interfaces. But participants aged 59.5 and over are generally entitled to transfer their entire acquired account balance to a rolling IRA without limitation. So, rather than limiting yourself to plan providers, especially if you are unable to address the concerns raised above, participants can review the cost and features of the services available through a rolling IRA from other suppliers.
The bottom line
Understandably, many participants do not want to do the research necessary to weigh in using a target date fund or managed account. One study found that the average person would spend more time each year planning their vacation than their 401 (k) investment options. And since the cost of a managed account is not a direct expense but deducted from returns on investment, it may seem less impactful. But that’s like buying a bespoke suit and not wanting to sit down with a tailor to take measurements. You will probably get something very close to a standard alternative but at a higher cost.
Many bespoke products require a certain investment of time to truly reap the benefits. The above points should provide a roadmap for anyone interested in or currently participating in a managed account service to start this process.
Alan Vorchheimer is a Certified Employee Benefits Specialist (CEBS) and Director of Wealth Practice at Buck, an integrated HR and benefits consulting, technology and back office company. Alan works with large corporations, the public sector and multi-employer clients to support the management of defined contribution and defined benefit plans.