Mind the Red Flags: Unraveling the Customization Claims of 401(k) Participant Managed Accounts
Last Updated: August 25, 2023
Investment performance is one of the three key drivers that have the greatest impact on your participants’ retirement readiness. However, this benefit comes with a lot of decision-making for your participants. The majority of your employees likely have no plans to become investment experts. Their ultimate objective is to enjoy a comfortable retirement.
A plan’s ability to properly help equip participants for retirement greatly depends on your decisions as a fiduciary committee. The investment choices provided to plan participants are your responsibility, and you have an obligation to act in their best interests. You should have a thorough understanding of the options you provide.
The aggressive marketing of 401(k) Participant Managed Accounts has become more common over the past few years, despite limited demand. As these accounts gain traction, there are three red flags you and your fellow fiduciary committee members should look out for. While participant managed accounts offer customization, it can be costly and unnecessary for most investors—potentially taking advantage of people who may not know better for the sake of quick commissions. Be mindful of these pitfalls when thinking about making managed accounts available to your participants.
Last week, we looked at our first concern regarding managed accounts – participant managed accounts lack objective performance benchmarking. Today, we’re tackling a different concern: participant managed accounts are not as customized as sellers would make it seem.
401(k) Participant Managed Accounts are Not as Customized as Sellers Would Make It Seem
Our next primary worry about Participant Managed Accounts is that they are not as customized as sellers would have us believe.
Sellers will frequently give participants the illusion of an individually tailored plan when it comes to participant managed accounts. While this is a nice thought in theory, in practice, it isn’t quite accurate.
Managed accounts are frequently presented as an option to replace Target Date Funds, which have come under scrutiny for their “One Size Fits All” model. The selling point of managed accounts lies in their promise of a tailored portfolio with expert management, allowing participants to enjoy a more personalized experience. However, upon closer examination, managed accounts exhibit striking resemblances to the way TDFs operate.
When a participant meets with an adviser, they collect specific data points that they then put into a specialized computer program, either an in-house or third-party platform. The program recommends a personalized investment portfolio for the participant. As they get closer to retirement, the participant’s portfolio is rebalanced to be more conservative. This “glide-path” approach is remarkably similar to Target Date Funds, but the key difference is that it considers each person’s specific risk tolerance and any outside investments.
While the idea may sound appealing, generally, most investors don’t have unique risk needs or situations that require personalized solutions, so customized plans won’t significantly differ for them. While the service may benefit those with an unusually high or low-risk tolerance or significant external assets, its portfolio allocation will not materially differ for most people.
Furthermore, in order to benefit the small minority of people, participants would have to share enough information to generate the “customization.” We fear that even these select participants will not provide the program with, say, a full accounting of their outside assets to justify the costs. As a result, the allocation between Target Date Funds (TDFs) and managed accounts is likely similar for the vast majority of participants.
The proof is in the numbers.
Based on a study by Aon plc in 2020, approximately 28% of participants had an equity allocation that differed by more than 5% from the typical Target Date Fund (TDF) glide path. Conversely, 12% had an allocation difference greater than 10%. Interestingly, 81% of participants are projected to achieve outcomes that are materially similar to a comparable baseline. ¹
For additional evidence, look no further than the case of Gosse vs. Dover Corp., filed in the U.S. District Court of Chicago in August 2022. The lawsuit argues that: “The Plan’s managed account services added no material value to Plaintiff or to other Plan participants to warrant any additional fees” and that the advice offered through the service was “not materially different than the asset allocation provided by the age-appropriate target date options.” ²
It is our view that, under the best circumstances, managed accounts offer true benefits to only a few plan participants who have specific and unique circumstances. However, for the majority of participants, these accounts are likely to resemble Target Date Funds (TDFs), with the added drawback of higher fees and potentially lower returns. For more information, read our blog on the Lack of Performance Benchmarking in Managed Accounts.
Evaluation of Managed Account services is crucial for plan fiduciary committees. Since sellers have a financial incentive to sell the service, they are more inclined to play down any shortcomings. It’s imperative that you have the necessary knowledge to accurately assess the value offered to your participants and help them stay on track for retirement.
The illusion of customization isn’t the only issue we have with 401(k) Participant Managed Accounts – learn about our Top 3 Red Flags here.
1) “Are Managed Accounts More Efficient Than Target Date Funds?” Aon plc, pg. 1. October 2020. https://insights-north-america.aon.com/white-paper/are-managed-accounts-more-efficient-than-target-date-funds
2) Gosse v. Dover Corp., N.D. Ill., No. 1:22-cv-04254, complaint 8/11/22. https://www.napa-net.org/sites/napa-net.org/files/Gosse%20v.%20Dover%20Corp_081522.pdf
Pension Consultants, Inc. is registered with the U.S. Securities and Exchange Commission as an investment adviser, located at 300 S. Campbell Ave., Springfield MO, 65806. For questions or more information contact us at 417.889.4918.