Personalization is catching on in 401(k) plans, but there are two challenges that remain to be addressed:
- You cannot “manage” money for someone you don’t know who will not talk to you.
- There are no benchmarks, so participants can’t know how they’re doing.
Both challenges are addressed in the following.
Master PTDA as a QDIA
I’ve written extensively about “Smart Personalized 401(k) Investments.” Simply stated, the only PTDA that can be a viable QDIA is a single one-size-fits-all-set-it-and-forget-it “Master PTDA” customized by the plan’s sponsor to reflect workforce demographics. Since defaulted participants won’t tell you their needs and wants, the best you can do is make an informed decision for all of them.
The benchmarks for this flavor of PTDA are straightforward. Since everyone is on the same path, they each earn the same age-based benchmark return. For reporting purposes, you could set up and track a series of “Tracker Accounts” for hypothetical participants retiring midyear in 5-year or 10-year target years, following the “Master Glidepath” created by the plan sponsor. If you’d like to know if the underlying funds are adding value, you could set up a parallel set of Tracker Accounts that invest in index benchmarks.
So, if you use 6 target dates like 2010, 2020, 2030, 2040, 2050, 2060, you’ll have 6 benchmarks that invest in the actual underlying funds and 6 that invest in passive indexes. Voila!!
PTDAs for self-directed participants, which are NOT QDIAs
Self-directed participants want to engage, so they can and should manage their own unique PTDAs. They should be allowed to change their risk preference and their retirement date whenever they want.
Since each such account is unique and personal, it is challenging to benchmark, but a family of benchmarks like those in the following matrix will help these participants put their actual performance into perspective. They own their performance, so they should be able to evaluate themselves.
Practicality
To summarize, the advisor or recordkeeper maintains 12 benchmarks for defaulted participants and 18 for self-directed, for a total of 30 Tracker Accounts. Setting this all up should not be hard to do and—once that’s done—computers have no problems crunching the appropriate results.
Defaulted participants should see the 2 benchmarks that are closest to their expected retirement date. Non-defaulted participants see the 3 benchmarks that are closest to their retirement date, and they could see the entire matrix if they choose.
Stress Testing the Risk Choice
In a recent article I identify two distinct groups of TDFs. The “Risk On” group has been winning the performance contest until recently. And if we look back to recent market declines, we see that stress testing risk at the target date reveals the prudence of Risk Off. Protecting a portfolio comes with an opportunity cost in rising markets that is payment for avoiding losses near retirement. That is the trade-off: greed or fear. Protection is prudent.
The low risk benchmarks are “Risk Off,” as are the SMART target date fund indexes. High risk benchmarks are “Risk On” as are Industry consensus indexes like the S&P target date indexes.
Conclusion
Because investing is personal, the movement toward personalizing 401(k) investments is good. Target date funds have not evolved in the past 16 years, and they need serious improvement. The challenges of benchmarking personalization should not impede improvement. Benchmarking is definitely possible. Where there’s a will, there’s a way.
The lack of improvements in TDFs can be attributed to not fixing what is not broken. Risk has been rewarded for the past 16 years, the longest bull market ever. That will change. Unlike 2008 when $200 billion was invested in TDFs, this time there’s over $4 trillion, so a 20-times shock effect that will beg to be fixed; personalization will be part of that solution.
Ron Surz is president of PPCA Inc and its DBA Target Date Solutions (TDS), co-host of the Baby Boomer Investing Show (BBIS), and author of the book "Baby Boomer Investing in the Perilous Decade of the 2020s." TDS licenses target-date fund usage of Ron’s patented Safe Landing Glide Path® (SLGP) that actually protects beneficiaries as they approach retirement. Individual investors can follow the SLGP at Age Sage, an educational interactive website. The BBIS educates baby boomers on the risks and rewards in contemporary investing, and Ron’s book is a tour of these shows.
Ron can be reached at Ron@TargetDateSolutions.com.