FAAF/EC – Risky Business

Target-date funds have been the focus of a lot of attention recently, and are considered by many plan sponsors to be an attractive option because they compensate for participant inertia, automatically adjusting to make the changes an active participant would be expected to make over time.

Unfortunately, there is no real consistency in the asset allocation mix used within these funds, in the funds’ objectives, or even in defining what the “target-date” might represent. Without an established measuring process, benchmarking and comparison of funds can be very difficult for plan sponsors, and even the terminology used to describe these types of funds leaves something to be desired.

While it is true that risk-based funds are not always a better option, a panel at PLANSPONSOR’s Future of Asset Allocated Funds Conference (FAAF) – East explored why risk-based solutions might be the right choice for your retirement plan.

More Personalized

Michael Joss, Executive Vice President of Fiduciary Investment Advisors, began by describing what actually happens when a plan sponsor chooses a target-date or risk-based fund. One of the problems of target-date funds, he claimed, is participant interest in customization; many do not believe that everyone of a certain age should be placed in the same fund, and want something more personalized than a standard, off-the-shelf glide path. Offering roughly three to five funds that range from the very conservative to the very aggressive can help participants to choose and plan sponsors to focus on more individualized levels of risk in their funds.

In terms of risk-based funds and how they are implemented, compared to target-date funds, Joss said that education and communication are key. While “customized risk portfolios” sound like an ideal solution, they will not work properly unless participants take the time to go online, fill out a questionnaire, or at least have some kind of involvement. In this sense, target-date funds can be easier because knowing a person’s age is less complicated than figuring out a risk profile that is likely to change with market fluctuations as well as time.

However, he said that if a plan sponsor is willing to put in the necessary time for such a plan, it could work out extremely well for participants. Joss suggested an annual report to encourage more client participation; the development of a tool for regular evaluation for participants would likely lead to higher rates of activity and participation. Risk-based funds have the ability to be very customized and very effective if participants and their plan sponsors are willing to make that effort.

The Importance of Education

John Cate, Senior Vice President at Morgan Stanley, also stressed the importance of participant education when making this decision. Understanding that most participants, through inertia, do not take on enough risk and have trouble managing their own portfolios, his group took a kind of paternalistic stance when picking target-date funds.

Target-date funds do work, he said, but they are not always the best option. Cate said that education should give participants the incentive they need to be more active in their retirement plans and make the necessary effort with their funds. If they want their plan to be successful, the extra work required by risk-based funds is both crucial and beneficial.

Plans do not need to be managed to a specific point in time, but participants should know what they own and why, and be comfortable with their individual funds, he said. Giving participants access to fact sheets, showing them the analytical work being done on the overall investment portfolio as well as the due diligence that is put into their plans can go a long way to inspiring them to have greater input and ultimately more successful retirements.

Brett Howell. Wealth Management Advisor for the Howell & Sharp Group at Merrill Lynch, noted that participants, given the understanding that they can "invest and ignore" their target date funds, might not really know what they are getting into with those funds. In a risk-based fund participants know from the beginning how much risk they are taking with their investments. He suggested one-on-one meetings, but said that even more important is making sure that participants are contributing enough to their investments. Many people are inclined to have contribution rates of only five or six percent, but something closer to nine or ten percent is more likely to be effective.

Different risk models do call for different contribution rates however, with lower risk funds calling for high contribution rates and higher risk funds requiring less of a contribution. Howell recommended finding the balance of appropriate risk tolerance for each participant to go with an appropriate investment vehicle that the individual will actually stay invested in over a long period of time.

- Sara Kelly

Risky Business-Why Risk-Based Funds Are "Better"

They're older, have established track records, and-by some accounts-are better suited to take into account individual participant needs. Why risk-based fund solutions might be the right choice for your retirement plan.

Moderator:Steff Chalk , President, CHALK 401(k) Advisory Board, Inc.


Brett Howell,Wealth Management Advisor , The Howell & Sharp Group at Merrill Lynch
John Cate,Senior Vice President, Morgan Stanley

Click here to download!

Click here to stream!