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The beauty of a Target Date Fund (“TDF”) is that you can just sit back, relax and enjoy the show. You need to do nothing. If it’s the default investment option in your 401(k), you don’t even have to make a decision to opt into it. The plan does it for you.
But TDFs do raise some questions. More and more, 401(k) plan participants are looking for alternatives. And more and more plans are beginning to provide those alternatives.
One such alternative is something called a “managed account.” Is it right for you?
“A managed account will be a little more customized in nature than a target date fund,” says Michael Fischer, Director, Wealth Advisor at Round Table Wealth Management in New York City. “The investment manager may tweak allocations as market conditions dictate and will usually incorporate a broader selection of the market than target date funds. Target date funds typically are comprised of an underlying broad equity fund and a fixed income fund. A managed account may contain other asset classes like REITs or commodities and can be more targeted to market styles like value or growth.”
It’s now understood that one size doesn’t fit all. That’s the fatal flaw of a TDF. But just because a TDF might not be right for all people doesn’t mean it isn’t right for some people.
“A TDF assumes one size fits all, and clearly that is not a good choice for many plan participants,” says Linda Erickson, Founding Partner and Financial Advisor at Erickson Advisors in Greensboro, North Carolina. “A larger account, a more sophisticated or experienced investor, can benefit from a managed account which might take more, or less, risk than an age-based TDF. For smaller or start up plans, a TDF choice is a good one for inexperienced plan participants who might opt out of having to choose a managed fund.”
For these people, the opportunity to set-it-and-forget-it is simply too good to pass up. They’re satisfied with what they get, and the drawbacks don’t concern them. If you are concerned, or if you don’t know if you should be concerned, you should consider something like a managed account.
“TDFs are great for people who want to set it and forget it and are comfortable living their financial lives based on ‘rules of thumb,’” says Erik Sussman, Founder and CEO of the Institute of Financial Wellness in Fort Lauderdale, Florida, “The pros of managed accounts vs TDFs are that they are not ‘cookie cutter.’ A TDF is more of a one-size-fits-all whose investment allocation is predicated on the calendar. As you get closer to the ‘retirement target date,’ the portfolio becomes more conservative. Managed accounts can be more customized to your goals and needs. For example, you could choose to be more aggressive in your 401(k) because you have other safe buckets outside of your retirement account and this can be better accomplished with professional money management as opposed to a TDF. You have more control over the asset allocation in a managed account vs. a TDF.”
This customization and flexibility, then, represents the key advantage of managed accounts over TDFs.
“TDFs tend to maintain allocation to asset classes through your life glidepath, only adjusting the overall allocation slightly,” says Fischer. “For example, the Vanguard 2045 and 2050 target date funds only have a 2% difference in their allocation to stocks. Over the course of the next 5 years, the 2050 target date fund will only look to rebalance slightly by reducing equity 2%. A managed account may be more aggressive, or more conservative, given overall market conditions and may fluctuate more year to year.”
What exactly does “customization” mean? It means different things to different people. Why? Because of the relevancy of the number of factors involved. Those factors may be critical to one person, but impertinent to another. Where do you fall?
“Managed accounts typically consider multiple personal data points such as age, risk tolerance, income, gender, and other assets in determining the appropriate allocation of assets between stocks, bonds, and cash,” says Paul Swanson, Vice President, Retirement at Cuna Mutual Group in Madison, Wisconsin. “TDFs only consider age. So, an older investor with a large account balance, complex planning considerations and substantial outside assets could benefit from the personalization offered by managed accounts whereas a younger investor with little to no outside assets would do just fine in a TDF.”
One of the things to keep in mind about personalization is that it’s not necessarily meant to provide higher returns. It’s meant to make you feel more comfortable and to give you a better chance of aligning your retirement portfolio with your personal situation.
“In theory, a managed account can provide a more fine-tuned asset allocation for an investor compared to a TDF if a participant is engaged, enters appropriate data, and has sufficiently differentiated investment needs or objectives,” says Bill Ryan, Partner at NEPC, Head of Defined Contribution Solutions in Chicago. “However, the magnitude in which that personalization changes the investor’s asset allocation may be relatively small, and the benefit may not be realized by most and may be hindered by the additional fees of managed accounts.”
You’ll likely pay more for a managed account than a TDF. You will have to consider if the potential comfort is worth the extra cost. Bear in mind, though, this cost will be higher if the managed account includes investment products rather than just stocks or bonds.
“A managed account will be more expensive than a target date fund,” says Fischer. “Target date funds will have a very attractive fee offering of about 0.15-0.5%. A managed account will typically have an ‘assets under management’ fee along with the underlying fees of the investment products. The investment manager should work to outperform their respective fee, but for those who are fee sensitive, the target date fund may be a more attractive option.”
One way a managed account does outperform is in its ability to react immediately as market opportunities arise. This can be particularly significant based on the position of the interest rate cycle today.
“With a managed account, your risk can be managed based on what’s unfolding in real time in the markets rather than a predetermined time in the future,” says Matthew Grishman, Principal, Wealth Advisor at Gebhardt Group, Inc. in Roseville, California. “TDF’s have a built-in flaw that’s not discussed often in public conversation. Generally speaking, TDF’s will slowly transition from stocks, which are perceived to carry more risk, to bonds, which are perceived to carry less risk, as you move closer to retirement. There is a major flaw in this thinking. Bond prices are generally affected by the direction of interest rates. As rates decline, bond values go up. As rates increase, bond values generally decline. We are currently in the lowest interest rate environment in US history, which also means we are at or near an all-time high in bond prices/values. Should rates begin to normalize and rise over the coming months and years, we could start to see price depreciation in the overall bond market, just as many TDFs begin to shift from stocks into bonds. The result could be disastrous for TDF investors nearing retirement, should they begin to see a spike in interest rates coinciding with their target retirement date.”
Another popular aspect of managed accounts is their transparency. Unlike mutual funds, including TDFs, you don’t have to dig for information on what’s inside them. (And even when you do find out what’s in a mutual fund, there’s usually a big lag between what you see reported and what’s actually in them now.)
“In TDF’s, the holdings are owned in a fund format, and understanding what is owned in the fund takes a little further research,” says Todd Scorzafava, Principal/Partner with Eagle Rock Wealth Management in East Hanover, New Jersey. “You need to look at information the fund discloses or that is provided from other resources to see what holdings are owned. TDFs though allow you the time to focus on more of what you should be contributing to the fund vs the ‘time taken’ to be managing it yourself. TDFs also do a lot for you automatically, rebalancing and adjusting for you over the years.”
The real risk with managed accounts is that you might pick an adviser who’s in a slump. Making matters worse, this is something you won’t know for years, so you are taking a chance.
“You could get ‘stuck’ in investments that are not appropriate for you if you do not have a good financial advisor guiding you and making necessary changes if and when your goals and objectives change,” says Sussman. “The key here is that you need to have an engaged and involved advisor. If they are not attentive to your situation and the changing economic environment, then you might have been better off saving the fee and investing in a TDF.”
In either case, not all plans offer managed accounts. “They are less available in most 401k plans,” says Scorzafava. “TDFs are becoming very popular in Retirement/401(k) plans. Again, pros and cons are mostly dependent on the individual and what the right fit is, with the goal being to act and invest to help get you to and through retirement.”
Don’t forget, there may be other choices in your 401(k) plan. If that’s the case, be sure to check out these articles:
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