Placing a group of employees into the same 401(k) fund allocation formula portfolio is a little like demanding a track team to wear the same size shoes based on the average foot size of the team.
Some runners would fall out of their shoes during the race, while others would be stuck in the locker room trying to wedge the shoes onto their feet. As a retirement plan sponsor, it is your responsibility to make sure your 401(k) offers portfolios that are the best fit for your team.
Almost every 401(k) plan offers target date funds (TDFs) to participants. And for many plans, it is the default investment option many participants end up in. This is usually done regardless of their current financial condition or tolerance to risk. This could cause problems for the participant in the future.
First, know that TDFs have glide paths, also known as fund allocation formulas. These formulas determine how the assets in a 401(k) portfolio change as the target date (retirement) approaches. When the target date is far off, funds can be more aggressive. As the target date draws closer, the trajectory changes to a more conservative approach.
However, two different TDFs with the same target date might not have the same glide path. There can be for example, two TDFs with an expected retirement date of 2040, but one has an aggressive glide path and the other a conservative strategy.
Plan sponsors typically select the TDFs offered to their participants and are unaware their participants may require varying TDFs with different glide path strategies.
All TDFs are not created equal
While glide paths are guides, these plan sponsors and participants should understand that TDFs do not address the individualized needs and risk tolerances of each participant. While one 35-year-old may be inclined to be aggressive because they are behind on saving, another similarly aged participant may need a different mix of stocks and bonds to be less aggressive as an investor.
An ill-fitting TDF has significantly more consequences than a poorly sized pair of shoes. Chief among them is that participants may not be properly prepared for retirement.
A possible solution?
Should plan sponsors stop offering TDFs in their 401(k) plan? TDFs are a great tool for some plan sponsors and participants. TDFs rebalance themselves and are a great default investment, especially for plans that have automatic enrollment.
Plan sponsors no longer need to offer one TDF to participants of the same age. Depending on the plan’s record keeper, 401(k)s can have multiple TDFs, with the same target date and different glide paths (conservative, moderate and aggressive). This would enable each participant to select the TDF that suits his own financial situation and risk tolerance.
Look closely into the TDFs you offer as a plan sponsor. Do your TDFs/portfolios address individual needs allowing everyone to find the best fit to crossing their own well-deserved finish line?
Michael Pallozzi is President and Investor Coach with HFM Investment Advisors, LLC. HFM is a registered investment advisor in Glassboro that helps protect plan sponsors, guide positive participant outcomes and unifies service teams.
All investing involves risk including the potential for loss of principal. There is no guarantee that any strategy will be successful.
Published (and copyrighted) in South Jersey Biz, Volume 8, Issue 4 (April 2018).
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