Robert Powell: Is it time to ditch target-date funds in your 401(k)?


You wouldn’t be alone if you’re saving for retirement by investing in a target-date fund inside your 401(k) plan. 

Consider this: At year-end 2018, 27% of the assets in the EBRI/ICI 401(k) database, or $1.4 trillion, were invested in target-date funds and more than half of the 60 million 401(k) participants in the database held target-date funds.

And you’re not alone in thinking this one-size-fits-all mutual fund might be fine, especially when you’re young and just starting out.

But over time, these one-size-fits-all funds don’t fit everyone.

Yes, target-date funds (TDFs) do factor in your time horizon, your anticipated date of retirement. And they do rebalance how the assets are allocated over time.

But they don’t always factor in your tolerance for risk, your investment objective, what other assets you (and, for some, your spouse) might have earmarked for retirement in a traditional IRA, a Roth IRA, or other employer-sponsored retirement plans.

In essence, these funds are the near equivalent of giving everyone in a room a size 9 shoe, as Robert Merton, a MIT professor and Nobel Prize winner, said recently.

So, what’s the better option?

Well, if offered in your employer-sponsored retirement plan, some suggest using a professionally managed account. A managed account is, like a TDF, is a qualified default investment alternative or QDIA. New 401(k) plan participants are often defaulted into a QDIA, typically a target-date fund.

And one big difference between a managed account and a target-date fund, is that the latter is a one-size-fits-one fund. According to John Hancock, there’s “professional guidance from an investment adviser to help a participant develop a financial plan based on his or her unique circumstances and a customized portfolio of investment options chosen from the plan’s lineup and personalized to the participant’s financial plan and investment preferences.”

To be sure, plan participants aren’t so fond of managed accounts. Just 5% of 401(k) plan participants save for retirement using a managed account.

But plan advisers are fond of this offering.

“In a perfect world, we think managed accounts, properly priced, should be the QDIA,” said Mike Kane, the founder and managing director of Plan Sponsor Consultants. “TDFs only have one variable and balanced funds have none.”

Yes, as with most investment options, managed accounts do have pros and cons.

Managed accounts are both a simple and a complex topic all at the same time, according to Michael Doshier, a senior defined contribution adviser strategist with T. Rowe Price.

One negative and one reason why managed accounts are little used by plan participants has to do with cost. Managed accounts typically charge an additional 0.4% to 0.6% in addition to the underlying fund expenses, according to a recent AON report.

But those costs are reasonable given the benefits, according to Kane. “I believe when TDFs are compared to managed accounts in an up or down environment, managed accounts have demonstrated their efficacy in numerous studies, net of fees,” he said.

In other words, you’re paying for personal advice. And such advice would cost upward of 1% of assets outside of a 401(k) plan.

Others would also say, according to Doshier, that operational complexity, especially when considering making the managed account the QDIA, and overall participant engagement have been primary hurdles.  

“While all of these are true, the landscape is shifting,” Doshier said in an email. “More and more providers — recordkeepers, independent fiduciary platforms as well as most advisory firms — are bringing new products to market.”

In fact, the T. Rowe Price 2020 Defined Contribution Consultant Study revealed that more than half of the largest defined contribution advisory firms in the country place their managed accounts products as one of their largest growth opportunities.

So, who might consider using a managed account?

In the past, Doshier said the thinking has typically been that plan participants nearest to retiring should consider using managed accounts – specifically because there are myriad complex financial decisions to be made, such as sources of income, retirement spending, changes to level of risk, and the like. 

“More recently, a common practice that has emerged is to offer plan participants a chance to opt into a managed account midcareer which then automatically switch participants into a managed account when a certain trigger has been reached, such as age, asset threshold or a certain level of engagement,” he noted.

Kane said plan participants within 10 years of retirement should consider moving from a TDF to a managed account, given that it will be a more personalized portfolio.

And what should plan participants consider when contemplating a managed account?

“When it comes to retirement, it’s not one size fits all,” Doshier wrote. “Many participants today need help regarding how to invest savings or how to calculate a budget in retirement. Managed accounts are one way to receive that assistance.”

Given that, one must consider how managed accounts can deliver advice in a simple, personalized way while also helping to ensure that their needs in retirement are being addressed and they’re “retirement ready,” wrote Doshier.

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