Do you see it? Fidelity just issued a report saying the number of 401(k)
millionaires has grown by 45% since last year. Of course, it took them three
decades to get there.
On the face of it, given the joys of compound interest, this shouldn’t
surprise anyone. Yet, these two data points reveal much more.
These 401(k) millionaires are fast approaching the cusp of retirement.
Yet, chances are, their assets are invested solely in mutual funds. This may
soon present a problem.
You see, during their career as employees riding the commuter train to
retirement, mutual funds are a quite acceptable investment. As they approach
their destination (retirement), that train may not leave them off in a place
best suited for them. Trains can only stop at designated stations. Granted,
those stations may be close to where they want to be, but it’s more than likely
not.
“What’s the big deal,” you might say, “just take a cab and everything
will be all right.”
That’s certainly true, but how many employers feature a cab stand as
part of their benefits package?
Don’t be surprised if they do in the near future. We’re already seeing
baby steps in this direction.
Interest in and use of managed account options within 401(k) plans has
grown over the last decade. There remain kinks that need to be worked out, but
as more employees find their retirement assets exceeding 7 digits, they’re
discovering the value of using a personal portfolio manager rather than relying
on investing’s equivalent to public transportation.
Why is this important to plan sponsors?
It turns out this cab stand idea isn’t relevant just at the point of
retirement. It’s in the best interest of employees to begin the process of
preparing for retirement no later than five years before their retirement date.
This gives the employee time to assemble retirement and non-retirement assets
into the proper investments – and for large accounts that increasingly means
individual stocks and bonds.
“Now wait a minute!” I can hear you saying, “I thought index funds
solved this whole thing.”
Well, let’s not get into that debate. Instead, let’s look at what most
researchers agree on: index investing is great when it comes to long-term
upside, but dangerous when it comes to short-term downside protection.
It makes sense, for example, for retirees to construct a laddered bond
portfolio rather than invest in a “bond” fund. (If you don’t understand why
this is so, you probably also don’t understand why I put the word “bond” in
quotes. The quick answer is this: Funds that invest solely in bonds are
equities, not bonds, despite the nature of their underlying investments.)
How might we begin to see retirement plan options begin to incorporate
this “cabstand” approach?
For new and medium-term employees, they wouldn’t treat their 401(k)
decision making any different than they do now. In all but the rarest of cases,
riding along on the mutual fund express is the quickest and easiest decision
for them to make.
Veteran employees, on the other hand, may want to understand what the
cabstand means to them. For one thing, customized attention isn’t free. They’ll
likely have to pay out of their plan assets, for the privilege of personalized
service. That means they’ll need to recognize the value before they agree to
pay for it. As with any innovative offering, the early adopters will lead the
way.
I would maintain those with “managed options” are the early adopters.
And by “managed options” I’m not referring to a portfolio of mutual funds – any
robot can do that given the typical limits of plans. I’m talking about
full-fledged individual stock and bond portfolio.
You know the kind I’m talking about. Old time hockey. The kind of
portfolio Eddie Shore hired a bank trust department of Investment Adviser to
manage.
The key to this, though, is this “cabbie” won’t be limited to managing
the employee’s retirement assets. Nope. No employee wants the expense of hiring
two managers – one for retirement assets and one for taxable assets. The
cabstand will be able to tackle both.
Remember, the employee is paying for this service, not the company or
the plan.
The only question is, should the company remain holding the
fiduciary liability associated with vetting the manager the employee chooses?
That, as far as I know, is a case that has yet to be fully tested.
Click here for the original article from Benefits Pro.