Should You Include a Managed Account Option in Your 401(k)?
There’s a lot of talk about managed accounts these days. But what exactly is a managed account?
A managed account is a 401(k) option whereby a professional manager sets the asset allocation for the participant, and then builds a portfolio from the funds in the lineup. The managed account’s asset allocation is designed to reflect the participant’s age and other personal information. As the employee grows older, the allocation can be tweaked to increase the exposure to (more conservative) bonds and reduce the allocation to (more volatile) equities. These asset allocations may be computer generated based on the employee’s responses to a series of questions, or an investment advisor may have a hand in portfolio design, perhaps choosing from one of several model portfolios that vary by level of risk.
If some of this sounds familiar, that may be because target date funds (TDFs) are also designed to automatically shift asset allocations as participants age. Participants pick a TDF with a “target date” that matches the year they expect to retire. As time goes on, the TDF shifts the allocation toward bonds and away from equities until it reaches a predetermined asset allocation in the targeted retirement year. The 401(k) will typically offer a family of TDFs, each with a different target date.
The Traditional 401(k) – Life Before Managed Accounts or TDFs
Before we talk more about the differences between managed accounts and TDFs, let’s back up a bit.
Prior to TDFs and managed account options, the traditional 401(k) asked a lot of its participants. First they had to wade through a stack of forms to enroll in the company retirement plan. And then they had to decide how much of their salary to contribute to the plan each month. After they accomplished those tasks, they had to become their own investment manager.
Ideally, that meant understanding the long term risk and return characteristics of stocks and bonds, and then deciding how much to allocate to each of these broad categories. And those decisions were just the beginning. Participants then had to select funds from the lineup to deliver the desired allocation. And that meant knowing the difference between growth and value stocks, deciding how to weight small vs. large caps, and even how much international exposure to assume. Even choosing bond funds could be complicated, particularly if the lineup included very short and very long duration funds, high yield funds, and international bond funds. These are huge demands to place on employees, particularly those with little experience in finance.
Given this workload, it’s easy to see why an employee might simply leave all those contributions un-invested. Rather than try to decode the world of finance, an employee might simply ignore all those 401(k) statements with the idea of getting invested someday.
On the other hand, participants might haphazardly select a few funds from the lineup without knowing if those funds are suitable for them.
Enter the Hero: Target Date Funds
And then, along came target date funds.
TDFs are the investment manager. The TDF handles asset allocation – and fund selection. And the asset allocation changes according to a predetermined “glide path” that gradually reduces equity exposure as the target date grows nearer.
Not only that, the TDF performs the portfolio management task of rebalancing. Rebalancing ensures the portfolio retains the appropriate asset mix regardless of market conditions. This prevents a booming stock market from skewing the portfolio too far toward equities, and keeps a sinking market from leaving the participant under-invested in stocks. Instead, investments are tweaked periodically to keep asset allocations at the appropriate level.
The result? The 401(k) investor no longer needs be an employee and an investment manager. The TDF takes on that important job.
But doesn’t the participant still have to invest in the appropriate TDF to get out of the portfolio management business? Maybe, maybe not.
Many 401(k)s today offer automatic enrollment once employees become eligible to join the plan. And often, the default investment is a TDF appropriate for that particular employee. That is, the TDF is often the Qualified Default Investment Alternative (QDIA). The employee is not only automatically enrolled, that employee is automatically invested.
The managed account option is designed to be a more comprehensive approach to this “set and forget it” process. In addition to accounting for a participant’s age, a managed account may also take into consideration salary, other employee benefits, and additional investments the employee owns outside the company 401(k). And like with the TDF, the managed account will continue to manage the employee’s 401(k) investments, adjusting asset allocations, and rebalancing when necessary.
This customized approach to asset management typically costs more than the target date fund approach. So it’s up to the plan sponsor to determine if benefits from a managed account justify the extra fees. Plan sponsors should be especially careful if their advisor receives additional compensation if they persuade plan sponsors to include managed accounts as an investment option.
Plan sponsors should also know that managed account fees can be greater for smaller plans. So if you are thinking of including a managed account option, be sure to understand the fees involved and compare the approach to offerings by competitors.
While there is growing interest in managed accounts, TDFs are far more common. According to research performed by Vanguard on accounts where it serves as recordkeeper, 92% of plans offered target date funds in 2016, while 27% offered a managed account option. For plans with fewer than 500 participants, 86% offered TDFs while just 11% offered managed accounts.
When it comes to default investments, TDFs continue to rule the roost. Just 1% of Vanguard plans chose a managed account as a QDIA while 83% selected TDFs.
As is the case with so many aspects of running a 401(k), a managed account option may or may not be a good fit for your plan. It depends on you and your employees. If a large percentage of your employees have complex finances and own considerable assets outside the 401(k), you may decide that the managed account approach justifies the cost.
Our Own Virtual Advisor
At ForUsAll we can provide employees with a great low cost fund lineup and guidance with their investments. We recommend that participants be automatically enrolled and invested in a low cost TDF appropriate for their age. And, we have our own onboarding expert available 24/7. That’s DAVE, our award winning virtual advisor who can explain your plan’s features to employees. DAVE can also lets employees know what auto-enrollment options have been selected, and shows your employees how to automatically increase salary deferrals every year.
If your employees still have questions after DAVE explains your company’s plan, we have real live investment advisor representatives to answer them – even if the questions don’t have anything to do with the 401(k).
Give us a call to learn how our team of investment advisor representatives can answer investment and employee wellness questions, and how our operations specialists will keep your plan administration running smoothly.