Fabulously wealthy people can walk into a car dealership or clothing store and buy a custom-made product whether they need it or not. But assuming you’re not Jeff Bezos or Elon Musk, the decision to spend more on a bespoke alternative to what is on the showroom floor needs to be carefully weighed. And in the world of 401(k) plans, what factors should you consider before deciding to purchase a customized asset allocation for your plan balances?
For participants who want a do-it-for-me approach to allocating their plan balances, more than 80% of 401(k) plans now offer a suite of target date funds (TDFs). These are prepackaged, age-appropriate investment strategies that are intended to help support post-employment income needs while reducing investment risk near and through retirement. This is accomplished through use of a “glide path” in which the fund’s asset allocation changes over time based on the participant’s retirement age.
Each target date fund makes certain assumptions about the average participant: These include assumptions about other benefits, such as Social Security, risk preferences, salary levels, saving behaviors, work spans, life spans and post-retirement spending behavior. In most plans, TDFs serve as the plan’s default option and contributions are automatically directed — unless the participant elects elect otherwise — into the fund with year closest to their assumed retirement date at age 65. (For instance, someone born in 1970 would be defaulted into a Target Date 2035 Fund.)
Alternatively, around 40% of plans (higher for employers with more than 1,000 employees) also offer a service known as managed accounts. Managed accounts customize your asset allocation within a plan’s investment options based on your unique financial situation. In addition, many managed account services offer additional guidance on savings levels, when to start receiving Social Security payments and a sustainable decumulation strategy. But delegating the asset allocation and fund elections of a participant’s balance is at the heart of the service.
Fees for managed accounts vary but typically range from 20 to 50 basis points on top of the investment expense of the underlying plan funds. This can really add up over an extended period. For example, if you put $10,000 per year in a 401(k) plan over the course of a 30-year career at a 6% return, an additional 30 basis point fee will cost approximately $50,000 over the period.
For more on whether you are a good candidate for a managed account, please read “Should Your 401(k) Be ‘Custom Made’?”
Evaluating the target date investment strategy
To make a high-level determination regarding whether your plan’s target date fund is appropriate for your situtation, you need to understand the manager’s investment strategy. This is far easier than it sounds as you can typically find what you …….