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Tuesday, September 16, 2014

Why Most Target Date Funds Are Off-Target

As a basic premise, every 401k plan should enable every participant to maximize retirement savings on his Custom_TDFsor her timetable.  To accomplish this, plan costs should always be kept as low as possible and each participant needs be able to invest in a way that reflects his personal risk tolerance, thereby growing his account at a level of risk that is comfortable for him.  Consistent returns are clearly important as well.

Every plan needs to either provide education that enables the participant to create an appropriate, personal portfolio and then manage that portfolio on an ongoing basis or, provide some "managed" option that does this for the participant.  Given the well-documented failure of investment education and the resultant, miserable participant decision-making and results, the target date fund (TDF) concept has emerged as a solution.  Many plans offer them and they are attracting more assets than ever.

The intention of “off-the shelf” Target Date Funds is good.  They’re professionally constructed and managed, they eliminate much of the need for investment education and the fruitless effort to turn plan participants into competent investors, and they encourage a set-it-and-forget-it mindset.  But they also come with a bag of problems. To name a few:

  1. High cost - either because of actively-managed funds, management fees or both

  2. Nearly always comprised of relatively poor-performing funds

  3. Don't take into account the individual's risk tolerance

  4. Don't get re-balanced frequently enough (usually only yearly)

  5. As a result of #3, it's more likely that participants with a low to moderate risk tolerance will "run" when the market goes down. (TDFs are too aggressive in the early years for these people)

Properly constructed, there should be no cons to a target date fund.  However, customization is key.  A great TDF: 

  1. Can be low cost - via low management fees and use of all index funds

  2. Can provide persistently better returns - index funds outperform actively-managed funds 80+% of the time

  3. Reflects both the individual's risk tolerance and the various time horizons

  4. Is professionally managed

  5. Is re-balanced quarterly

  6. Encourages a set-it-and-forget-it mindset

The most critical aspect of the "target date" concept is that, when offered in a front-and-center manner, (i.e., not as just another investment choice among many), employees are not repelled by the complex, incomprehensible and off-putting jargon of investments, so they join the plan. Not saving (non-participation) is the single biggest problem for employees, and non-participation is the biggest reason that plans fail their non-discrimination tests.  Using target date funds properly can solve these and other problems to make every 401k plan successful for employee and employer alike.

The bottom line is this:  the success of TDFs in your plan (meaning they achieve the basic plan premises cited above) depends entirely on who builds the custom funds and how they are deployed in the plan.



Posted by Eric Kiesshauer at 10:00 AM
Friday, September 12, 2014

Friday 401k Fix: Dump Your Actively Managed Funds

How much do you really care about giving your employees the BEST shot for a secure retirement?  How expensive2much do you really care about your fiduciary duty under the law?  These are really the same question.  Legally, you don't have a choice but to care.

 Each week, we read dozens of 401k-related articles.  There is clearly a rising tide of experts evaluating the industry in a way that truly reflects reality.  They acknowledge all the shortcomings in the 401k industry.  They rightly suggest investing in index funds.  But then there is never a real solution.  Even in these similar-themed articles, with which we agree, we find an inconclusiveness that irks us—possibly the most irritating one is this one:

“Still, Actively-Managed Funds have their place in 401k plans.”

Why?  There is literally NOTHING to back this up.  Are some of these funds outperforming their index?  Occasionally.  But they don’t remain winners in the long term, there is no longevity to their outperformance and there is no way to pick which ones will outperform in the future!  You might think you’re paying some big shot from Merrill Lynch to do that for you, but multiple studies have proven that any “winners” an advisor picks are almost entirely the result of luck and not skill.

So we declare (again), it’s time to DUMP actively managed funds in your 401k plan!  They cost much more and, over time, they leave your employees with less.  If you take your fiduciary responsibility seriously (not just in a way to defend yourself in court), you have to care about the success of your participants.  They have to choose from the investments you offer in your plan.  It doesn't help to stack the odds against them.

Don’t believe us?  Start reading the evidence for yourself.  It’s all there.  As a plan sponsor, you have all the power to change your 401k plan so it truly helps the people it SHOULD help: your employees.



Posted by 401K Revolt at 10:00 AM
Thursday, September 04, 2014

Take The Road Less Traveled: A New 401k

Every time I see a Fidelity commercial featuring their clever "green line", I think: Wizard of Oz.Where_does_the_red_brick_road_go  Recall the good witch and an enormous cast of Munchkins, enthusiastically advising Dorothy to "follow the yellow brick road" to find her way to the wizard in Emerald City and ultimately back to Kansas!  As we all know, she takes their advice and sets out on the arduous trek with great expectations.   She experiences lots of ups and downs, gets both good and bad advice along the way and even convinces three new friends to join her on the yellow brick road to "success".   After days of staying the course, fighting perils that range from a wicked witch to fierce flying monkeys, they finally arrive in Oz, meet The Wizard and get what they came for! 

Well, not exactly.

Dorothy and company quickly learn that if they really want what they came for, more is going to be required of them.  They will need to deliver the broomstick of the Wicked Witch of the West!  This is such a challenging task it almost doubles the length of the film.  Amazingly, they pull it off, and return to the wizard to have their wishes granted.  Sort of.  All Dorothy gets is an offer to "go for a ride" from a sketchy old wizard.  Her 3 friends get worthless trinkets and a pep talk.  Thank goodness for the ruby slippers, or we would have all gone to bed crying and never watched the movie again!

Fidelity's Green Line and the Yellow Brick Road have a lot in common.  They've both been proven, over many decades, to be lousy routes to the much-desired goal.  Like the YBR, just when you think your trip on the Green Line should be over, you'll find that you need to work quite a few more years to reach your destination.  Why?  Because all the studies on actively-managed funds (we could call them "green line pavers") show that at a cost of 5-10x the cost of index funds, they under-perform their index well over 80% of the time.  A one percent difference in cost alone will yield a nest egg that is 28% less over 30 years of saving.  Better figure on fetching the witch's broomstick before you retire.   

The Fidelity's of the world and the commissioned salesmen who recommend them are much like the good witch and the Munchkins:  well intentioned maybe, but really bad advisors.   And it gets worse:  The Munchkins really thought the YBR was the best way to help Dorothy.  All the advisors today have seen the “movie” many times over.  They all know that the Green Line isn't the best way to get to your goal.  The only ones succeeding via the Green Line are Fidelity and their commissioned sales people. 

Back in Kansas, the YBR is just a dream, but Fidelity's Green Line is a stark reality.  401k plans are loaded with high-cost, under-performing, actively-managed mutual funds.  Sadly, many participants have been traveling down their own version of the YBR for years and now that they should be nearing Oz, they find themselves far from their destination.  But now the good news: Ruby Slippers!  Fixing your 401k is almost as easy as clicking your heels together.  The Green Line off-ramp is just ahead.  It's time to re-set the GPS.  Tell Siri to give it another shot.  Find the answer to the most obvious question in the movie.  The one neither Glinda or the Munchkins ever mentioned:  Where does that other road take me?  



Posted by Eric Kiesshauer at 1:15 PM