Posted on 18 June 2008
By Mark Miller
When it comes to your retirement portfolio, you’re in the driver’s seat. At the risk of sounding like a back-seat driver, here’s a thought: Maybe you should put it your plan on cruise control.
A majority of employers are adding what amounts to automatic portfolio management to the options you can choose in your workplace plan. It’s part of a broader overhaul of workplace retirement programs, aimed at dramatically boosting the amount of money people sock away.
Most people don’t save nearly enough to ensure a secure retirement. And many of those who do save don’t pay enough attention to managing their investments. It’s a subject many don’t want to think about, or find too complicated to deal with.
“People are governed by inertia, which happens when you have financial literacy issues,” according to Mark Iwry, a nonresident senior fellow at the Brookings Institution in Washington, D.C., and an expert on retirement security issues. “As a nation, we have that in spades.”
The result: We’re heading for a train wreck as baby boomers begin exiting the workforce because savings are a critical supplement to Social Security and other income sources in retirement.
Recent changes in federal law have encouraged financial services companies to offer employers a range of automated features. But the idea that’s really taken off is lifecycle-or target-date-mutual funds for 401(k) accounts.
These funds are about as close as you can get to no-maintenance retirement investing. Instead of sorting through fund options in your employer’s plan and making periodic adjustments, you simply pick a fund targeted for the year you expect to retire. The fund manager adjusts assets as the target year approaches, reducing the percentage of equities and increasing fixed-income investments to make the overall mix more conservative.
The Pension Protection Act of 2006-a broad set of reforms aimed at improving retirement security-contained provisions encouraging adoption of lifecycle funds, and a 2007 ruling from the U.S. Department of Labor (DOL) encouraged employers further by approving lifecycle funds as “safe harbor” investments. That meant companies can offer lifecycle funds without assuming legal risk in case employees lose money.
The changes have produced a flood of new investment in these vehicles. Assets in lifecycle funds rose 61 percent last year to $183 billion, according to the Investment Company Institute, and 88 percent of those assets were in retirement accounts.
And earlier this month, Fidelity Investments released a survey of its own clients confirming that the lifecycle funds are in overdrive. About two-thirds of plan participants had at least some of their savings a lifecycle fund at the end of the first quarter this year, up from just 8 percent at the end of 2005.
The DOL ruling gave safe harbor status to several types of automated savings plans. Along with lifecycle funds, balanced funds and managed accounts also were approved.
But so far, lifecycle funds appear to be winning the race. Among the more than 800 companies surveyed by Fidelity, 78 percent had adopted an automatic default investment option of some kind, and 63 percent of those had chosen lifecycle funds as the default. Another 14 percent plan on adopting a qualified default investment option soon, with the overwhelming majority saying they will offer lifecycle funds as the default.
“They’re popular because they are so simple-you pick a fund and it follows you to retirement,” says Mike Doshier, vice president of retirement services marketing at Fidelity. “A balanced fund is more static. And managed funds are more complicated for employers to implement.”
Some critics of lifecycle funds argue that their one-size-fits-all fails to take into account the needs of individual investors, and that you can earn higher returns by actively managing your portfolio. But here’s the reality: Overall participation rates in retirement plans are abysmal. And those who do participate just aren’t managing their portfolios, because most of us don’t have sufficient financial literacy to make investment choices ourselves.
Fidelity data shows that just 16 percent of plan participants make any kind of portfolio allocation in a given year. “People don’t actively manage their accounts,” says Doshier.
Overall, 63 percent of eligible employees participate in their employers’ defined contribution plan, according to Fidelity data. That figure is shocking, because it means 37 percent of eligible employees are leaving money on the table in the form of matching employer contributions and tax savings.
Here’s another abysmal number: Nearly half of Americans surveyed last year by the Employee Benefits Research Institute reported that their total savings (excluding real estate and any defined benefit pension) was less than $25,000.
So, if your employer offers an automatic retirement investment option, give some serious thought to pressing that cruise control button.