According to the Defined Contribution Institutional Investor Association (DCIIA) custom target date funds now hold $516 billion, which is about 15% of the $3.5 trillion total held in target date funds (TDFs). These funds are supposed to customize their glidepaths to best meet the demographics of plan participants, but this is just plain hype. It’s simply impossible to meet the disparate needs of a diverse group with a one-size-fits-all-set-it-and-forget-it glidepath.
The only way to provide true customization is with personalization. Effective personalization serves both defaulted participants and non-defaulted participants. In both cases, it’s all about the glidepath because asset allocation is by far the most important determinant of investment performance.
The critical requirement for an effective customized solution is sound risk management along personalized glidepaths.
Defaulted participants
Trying to design a glidepath for people who do not want to engage is impossible. You just don’t know what they need and want. But we do know the one demographic that they all have in common. They are all financially naïve. As such, they need to be protected. The fiduciary Duty of Care is like our responsibility to protect our young children from avoidable harm.
Surveys report that most defaulted participants believe they are guaranteed against loss as they approach retirement. That’s why they were shocked in 2008.
This argues for a glidepath that is very safe in the Risk Zone that spans the five years before and after retirement in order to reduce Sequence of Return Risk that can spoil a retirement with dignity.
Since the plan’s sponsor chooses the target date glidepath for defaulted participants, a Conservative selection that protects makes sense. But a personalized target date offering gives the sponsor choices like Conservative, Moderate or Aggressive. The sponsor chooses a risk level for the default, using the target date fund construct as the plan’s Qualified Default Investment Alternative (QDIA).
The sponsor makes an explicit risk decision, as I’ve recommended. This is a very good thing.
The U-shape in the glidepaths above optimizes post-retirement allocations as identified by Dr. Wade Pfau and Michael Kitces.
Non-defaulted participants
About a third of the assets in TDFs are from non-defaulted participants who are limited to one TDF on their 401(k) platform. These participants want to engage so they love the chance to build their own custom target date accounts. They don’t want to be limited to one TDF glidepath.
The personalized approach lets non-defaulted participants choose their risk and their retirement date, and lets them change their choices whenever they want.
In this way, each participant owns a customized target date account. This customization eliminates the one-size-fits-all shortcoming of TDFs. Note that these accounts are not QDIAs because non-defaulted participants manage them.
Undefaulting
Education and encouragement could persuade defaulted participants to change their minds in favor of managing their own personalized target date accounts—to undefault. In doing so they would move to something akin to a managed account, but it would be a managed account for non-defaulted participants, so not a QDIA.
Education should already exist. Defaulted participants should know how they are being invested. The encouragement would be to take back control with their own personal glidepaths, something like:
“We’ve chosen this path for you. If you’d like, you can choose your own path by …”
Conclusion
Personalized target date accounts (PTDAs) are the wave of the future. More are coming to market all the time. As with all new products, PTDAs come in various forms. Effective products serve all participants, providing meaningful choices and well-constructed glidepaths that manage sequence of return risk. Importantly, PTDAs can be provided for less cost than most TDFs and managed accounts.
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Ron Surz is CEO of 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. He can be reached at Ron@TargetDateSolutions.com.
