Your Default Investment is Your Most Important Investment
It's 2006. There's a new investment type in town and it's now allowed and encouraged to be the default investment in a retirement plan, helping invest-it-for-me unsavvy investors everywhere save for retirement using the good rules of investing...by putting their account on autopilot. Everyone is cheering!
It's 2010. Congress is spitting nails and hauling investment companies in for grilling. "Have you lost money in your 401k?" is on billboards in the midwest. Plan committees are shocked to learn that what's under the hood in these investments is not the same from investment company to investment company. Everyone is booing.
It's 2015. DOL has news for you (and a checklist): it's prudent to monitor these investments too. Everyone is scratching their head.
I'm talking Target Date Funds: Super easy, pre-made, autopilot portfolios that match up with the year closest to when you'll retire. You plunk your money in, the investing is done for you, and voila! - your savings are diversified with professional investment management watching over them, and your allocation gets more conservative as retirement approaches.
Target date funds (TDFs) are often the Qualified Default investment option (QDIA) in a plan. If you enroll but you didn't pick an investment selection, you end up in the Default and DOL gave you a safe harbor for setting this up in your plan.
Ah, but the devil is in the details again. Here's a quick run-down of why, if TDFs are your plan's default, these are the MOST important investment in the plan:
- TDFs are often the most widely used investment option. Since that's the case, as a plan sponsor or committee member, you should be asking: Does this fit the [default] average employee at our company? In order to figure that out, you need to be asking these questions, among others: How much education do our folks have? How much risk can they stomach now and right before they retire? What's the average savings rate? What savings rate is the ideal? Is the purpose of the plan to get them to retirement or to be the opportunity for them to save that they need to take action around?
- If target date funds are the most widely used option, they are also a target for scrutiny. Current litigation focuses on TDF fees and selection/monitoring. ERISA requires that you have a process for prudently selecting and monitoring ALL investments funds on an ongoing basis...including the ones with the majority of all the assets in them! Just like the others, how you chose this and why it was allowed stay in the plan should be easy to answer and demonstrate.
- "Conservative" doesn't have an agreed-upon definition, and maybe your retirement age doesn't agree with the national average either. Remember how the portfolio becomes more conservative over time? That varies widely from fund to fund. There's also the glidepath of how much is invested in equities at what point during a person's career and how that morphs over time. Some TDFs manage "to" retirement or "through," but what's your employee's expected retirement age anyway? There's risk exposure, differing philosophies on asset allocation and portfolio construction, active versus passive investment management, benchmarking difficulty (don't get me started), single or multi-manager approach, fee structures, and customized options on top of all that. What's going to be your strategy on how you make decisions and monitor all that, in the best interest of the average employee that doesn't pay attention?
- Target Date funds are easily misunderstood by employees. "I put half in the 2030 and then half in this fund." Oh? Why is that? "Well, the other fund had better performance." That was a real conversation from last week. For those employees that are not defaulting into a target date fund, there's still an education gap. Target date are used as all or none investments and depending on how they are explained, it can be confusing to an employee to only use ONE investment option when you've told them to diversify.
Hopefully this helps make sense of why your default investment is your most important investment.
If you have questions on target date funds - and they are certainly tricky - we have excellent tools to help you sort through the issues, choose what's best for your plan, and monitor the funds going forward that include both construction and investment performance. Hit us up on Contact Us page with your questions.