“Personalization” is the new buzzword in 401(k) Qualified Default Investment Alternatives (QDIAs). For example, 401(k)Specialist recently published Plan Sponsors Count on Personalization for Improved Retirement Outcomes.
Several investment management firms have introduced personalized target date accounts (PTDAs) that combine managed accounts with target date glidepaths.
It’s important to recognize that these newbies are as different as Yin and Yang—night and day. The following identifies the big divergences between Yin PTDAs and Yang PTDAs.
Yin PTDAs
Yin PTDAs use recordkeeper data to estimate the wealth of the defaulted participant. They assume that rich people can afford more risk, versus the counter argument that poor people need more risk because they have not saved enough.
Which is correct? Since the rich typically do not default, the high-risk option is rarely—if ever—selected as the QDIA by the Yin PTDA.
Most importantly, there’s much more to managing an account than an estimate of wealth. According to Investopedia an account is “Managed” when:
Armed with discretionary authority over the account, the dedicated manager actively makes investment decisions pertinent to the individual, considering the client’s needs and goals, risk tolerance, and asset size.
This is the dark side (Yin) of the PTDA approach because defaulted people do not engage to reveal their “needs, goals and risk tolerance,” so you cannot actually manage their accounts—period. You could manage the accounts of self-directed participants, but Yin PTDAs are not offered to them; Yang PTDAs are offered to self-directed participants.
Yang PTDAs, and Yang Custom Target Date Fund QDIAs
The Yang PTDA is designed for self-directed participants because they do want to engage, and it also gives plan sponsors the ability to custom build a target date fund (TDF) for all defaulted participants.
This bright side (Yang) of PTDAs actually facilitates account management (not as a QDIA), and it improves QDIAs by customizing them.
• Yang Dynamic Glidepaths for Self-directed Participants
Self-directed participants (SDPs) want to engage, and many like TDFs. About a third of the assets in TDFs are from SDPs, but they are limited to the one TDF that is on their platform. Note that this usage is not a QDIA because these participants have not defaulted. TDFs are not a QDIA when they’re affirmatively selected by non-defaulted participants.
Unlike Yin PTDAs that are not offered to self-directed participants, Yang PTDAs welcome their usage. Yang PTDAs give SDPs lots of flexibility in managing their retirement savings. Life brings its surprises that can change individual risk preferences through time. Yang PTDAs let SDPs move at will onto and in between the glidepaths in the following exhibit. SDPs manage their own unique personalized lifetime investment path through time; each path is unique to each self-directed participant. There are as many paths as there are non-defaulted users of Yang PTDAs.
The U shape in the above glidepaths is unique and designed to (1) manage sequence of return risk near retirement and (2) extend the life of assets in retirement by re-risking, following the guidance of Kitces and Pfau.
Also, the retirement date is recognized as the actual day rather than grouping the participant into 5-year or 10-year age bands. SDPs can change the retirement date at will. The system can be “tricked” by choosing a later or earlier date than actually anticipated. Earlier increases safety and later increases risk.
• Yang Master PTDA is a Custom TDF QDIA
The Yang PTDA structure gives the 401(k) sponsor great flexibility in designing a unique custom target date fund (TDF) QDIA for all, thus conforming to DOL guidance to match the TDF glidepath to the demographics of the workforce. Specifically, the sponsor chooses the appropriate risk for the QDIA by blending the Conservative-Moderate-Growth glidepaths shown in the exhibit above.
The sponsor builds a master PTDA for all defaulted participants that is a custom one-size-fits-all-set-it-and-forget-it target date fund QDIA. Academic lifetime investment theory argues for the very safe Conservative path in the exhibit. But current common practice (“Industry” in the exhibit} is much riskier even though providers say they follow the theory.
• Yang Better Investments
Importantly, the investments used in Yang PTDAs are intended to be the best in each asset class rather than limited to the proprietary funds of a particular investment manager as is the case with Yin PTDAs and most off-the-shelf TDFs. A common complaint about TDFs is that the underlying management is all proprietary, so you pay a fund company to hire itself as an asset manager in addition to its glidepath.
Conclusion
Fiduciaries need to recognize the Yin and Yang of PTDAs; they should not assume that all PTDAs are the same Zen, because they are not.
Personalization of 401(k) investments is terrific, but it’s important to understand its limitations, namely that you can’t manage accounts for people who will not talk to you. True personalization requires interaction / engagement.
The QDIA application of personalization is for the less wealthy since the wealthy do not default. The wealthy are financially literate, and they can buy all the help they need.
Fiduciaries can build a custom TDF that is basically a master PTDA for all defaulted people. The one demographic that all defaulted participants have in common is lack of financial sophistication, which argues for very low risk near retirement to protect against sequence of return risk. It’s like our fiduciary duty of care to protect our young naive children from harm.
401(k) participants need and want personalization because investing is personal. Self-directed participants want to engage with PTDAs, but this is not a QDIA.
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.
