For some savers, a managed 401(k)'s tailoring beats a target date fund
Target-date mutual funds
take the pain out of investing. Plan participants simply invest in a fund of funds that’s based on their expected retirement date — their time horizon — and, for all intents and purposes, forget it.
But there’s another type of 401(k) investment option that plan participants, especially those whose financial situations are more complex, might want to consider: the managed account.
“There is a spectrum of financial advice available to 401(k) participants,” according to "The Optimal Default for Defined Contribution Plans," a 2015 working paper co-written by David Blanchett, the head of retirement research for Morningstar Investment Management. “It ranges from ‘do-it-yourself’ at the lowest and least expensive end of the service spectrum, that is free, to a full-service personal financial planner at the other end. In between fall options such as target-date funds and managed accounts.”
What are managed accounts? A managed account is a service where participants provide personal information to a provider — much beyond their target retirement date and risk tolerance — and receive, for a fee, an individualized portfolio using the funds in the 401(k) lineup that are managed on an ongoing basis, according to David O’Meara, a senior investment consultant with Towers Watson Investment Services in New York City.
To be fair, not all plan sponsors offer a managed account at the moment. For instance, just 37% of plan sponsors offer a managed account option, such as those provided by Financial Engines or Morningstar, in their 401(k) plans, according to Callan Investment Institute’s 2015 Defined Contribution Trends survey.
How do they work? Managed accounts use a variety of methods; they don’t operate in a uniform fashion, says Ben Taylor, a vice president at Callan Associates in San Francisco.
What they do have in common, he says, is “a methodology for assessing the appropriate risk-return balance for someone saving for retirement, as well as a set of capital markets projections that will be used to construct the portfolios.”
So, when a participant signs up for a managed account service, information is gathered from the 401(k) recordkeeping system, such as age, balance, income and sometimes “information such as defined benefit pension benefits or whether an individual is entitled to retiree health care benefits," Taylor says.
“It is also common to allow participants to input information regarding their personal and household finances, including assets outside of the plan, and risk preferences and goals,” Taylor says.
And all those inputs, Taylor says, allow the managed account service provider to assign an appropriate target portfolio using the investment choices from among the options provided within the defined contribution plan.
Managed accounts, of course, aren’t free. “Participants pay an asset-based fee for this service, and as long as the service remains in place, the managed account provider will monitor the portfolio, including rebalancing and reallocating among the investment funds as necessary,” says Lori Lucas, an executive vice president with Callan Associates in Chicago.
Advantages
The advantages of a managed account, at least on paper, are many, say proponents. One is a personalized, customized portfolio that’s actively managed.
“There are three main levers that affect retirement readiness — savings rate, investment selection and retirement age,” according to Blanchett. “Managed accounts provide personalized advice on all three, while target-date funds provide only investment selection.”
In fact, Blanchett notes that the recommendations a participant gets from a managed account will “consider factors like outside accounts, savings rate, state of residence, other sources of income and the like, while a target-date fund only offers generalized investment selection based on age.”
And then, when participants enter or near retirement, some managed accounts, such as those offered by Morningstar, “provide participants with a holistic, sustainable drawdown strategy that tells them exactly how much money they can draw from each account, each year in the most tax-efficient way,” according to Blanchett.
3 ways to check if your 401(k) plan is wisely managed
In some cases, according to Blanchett, the managed account provider can also recommend annuities if they’re offered in the plan and provide advice about when to claim Social Security.
Other advantages: Many managed accounts come with phone numbers and/or online counseling options for additional guidance, says Scott Matheson, a senior director with CAPTRUST in Raleigh, N.C.
And, participants enrolled in managed accounts or who’ve received financial advice save more in their 401(k) plans, and stick to an investing plan. In fact, participants increased their savings rates by nearly 28% after signing up for managed accounts or getting advice, according to a Morningstar study of 58,000 participants.
And saving more, combined with a more personalized and diversified portfolio than with a target-date or target-risk funds, results in better retirement outcomes, according to Blanchett.
Disadvantages
Some managed account providers don’t spell out details on fees, performance and benchmarking, according to a 2014 Government Accountability Office report. Read 401(K) PLANS: Improvements Can Be Made to Better Protect Participants in Managed Accounts.
The advantages of managed accounts “can be offset by paying additional fees over time,” the GAO wrote in its report. “Providers charge additional fees for managed accounts that range from $8 to $100 on every $10,000 in a participant's account. As a result, some participants pay a low fee each year while others pay a comparatively large fee on their account balance.”
According to Matheson, costs are heavily influenced by the size of the plan and the size of the participant’s 401(k) account balance. In some cases, the managed account provider will, for a fee, make investment changes on the participant’s behalf and monitor the account for necessary changes based on changes to a participant’s previously captured inputs, says Matheson.
“Generally, managed account fees are assessed at the individual participant level for the management of that individual’s retirement plan assets and are in addition to — or on top of — the fees of the underlying funds/investment options that the managed account allocates to,” Matheson says.
Benchmarking performance is another problem for managed accounts. “Monitoring managed accounts as traditional investment options are monitored is challenging since these are individualized portfolios/solutions to each participant,” Matheson says.
Also, managed accounts are not a homogenous group. “Unfortunately today, the term managed account is used to refer to many different types of products, services and solutions,” Matheson says.
And, managed accounts results are also dependent on the participant’s involvement and engagement. Participants need to put good data into the managed account questionnaire. Otherwise, it’s garbage in, garbage out.
What to consider? Start by weighing costs and the benefits.
“Managed accounts offer the greatest potential advantages for those with more complex financial situations,” says O’Meara. “For those participants, a managed account service may be a cheaper option than getting similar assistance from an outside adviser.”
On the other hand, O’Meara says younger participants and others with less complex financial situations need to determine if they wouldn’t be better served by using a low-cost target date fund, if available. Read Are Managed Account a Better QDIA by Towers Watson.
Others agree. “If choosing between a managed account and target-date fund, participants should ask themselves, ‘Am I average?’” says Blanchett. “Participants who have outside assets or complex financial situations may benefit more from a managed account.”
Robert Powell is editor of Retirement Weekly, contributes regularly to USA TODAY, The Wall Street Journal and MarketWatch. Got questions about money? Email Bob atrpowell@allthingsretirement.com.