Articles

Retirement Rebooted

It’s one thing for people on the provider side of the retirement industry to offer innovations, recommendations and predictions about the future of 401(k). It makes quite a different impact when major companies implement big changes in their own programs. Intel is one large employer that has done so recently, and their retirement plan “reboot” made headlines. Their strategy is worth a second look, both for their broad-based approach to improving outcomes, and for some of the assumptions behind their new fund lineup.

One of the most interesting features of Intel’s changes is their opt-in “auto-enrollment” of current employees. Automatic enrollment has become standard practice for new hires, but what would happen if a company offered it to non-participating employees as well?

The answer is an impressive 60% adoption rate. The company reports that of the 5,000 employees who were offered auto-enrollment, more than 3,000 have opted in. That’s a huge boost in participation – especially considering that in 2013 participants will also begin automatic escalation up to 10% of salary. It’s a very simple, rather clever innovation that others can easily emulate. It’s also a reminder of how often the barriers to adoption are behavioral, not financial ones.

Streamlined and Targeted

A restructuring of Intel’s fund lineup is a big part of the plan’s enhanced appeal. One might argue cutting the range of options from 72 to 21 still leaves about a dozen too many. But we know how difficult it can be to present employees with a perceived ‘takeaway,’ even if the replacement is functionally the same or better. In this case the new lineup does seem to be an improvement, offering a more comprehensible set of options, from a brokerage window for the most active investors, to target-date funds for hands-off participants.

The target-date options are also interesting. Based on a mix of active and passive funds, they include some uncommon additions such as hedge fund investments and commodities. While that may seem very unusual in a 401(k) plan, adding more exotic elements to the target-date or managed-account mix has actually become something of a trend. Opinions differ on the wisdom of this approach. Is it a fad with the potential to sabotage participant returns? Or an innovation that makes the advantages of institutional and wealthy investors available to everyone?

Time will tell, and we certainly hope it’s the latter, but our analysis shows otherwise. A hedge fund’s lack of transparency is a challenging in this context, and even a diversified fund of hedge funds doesn’t eliminate the risk of not knowing the real value of the underlying investments. Since most hedge funds don’t trade in publicly held assets, those valuations can be suspect. That’s a significant hurdle for ERISA fiduciaries, and we advise caution for any retirement plan. Cost is another issue that ERISA fiduciaries must consider, and the jury is still out on whether commodities really offer enough diversification value for what they cost.

A Better Solution?

For better or worse, it’s fairly certain that adding intensively-managed underlying funds will raise the costs of the target-date options. This is not a trivial distinction, particularly since the key benefit of target-date funds is that they offer ample diversification at a supposedly low cost. Considering that the net expense ratios of popular target-date funds can easily exceed a hundred basis points, we have to ask: is there a better all-in-one solution for the less-involved investor?

We’ve always believed that managed accounts provide such a solution. We said it before, back when target-date or lifecycle funds were the new big thing in retirement investing. Now that they’re the default option in many plans, it’s worth re-examining the comparison.

People, Not Numbers

The fundamental advantage of managed accounts is that they are based on investors, not ages or dates. Depending on how it is implemented, a managed account takes into account age, expected retirement date, risk tolerance, contribution rates, financial needs, and non-plan assets, working toward an investment goal driven by projected income replacement. Whether you’re playing financial catch-up, or ahead of the game and considering early retirement, only a managed account can meet your individual needs.

It’s true that both approaches support participants with a “set-it-and-forget-it” mentality. But behind the scenes, a managed account provider can regularly rebalance, reallocate, and readjust risk for the individual, accounting for market conditions, with fiduciary supervision. A target-date fund will be adjusted too, but only “automatically” and in the aggregate as it glides toward its destination.

Many investors learned this difference to their dismay in 2008. While the markets crashed to earth, their retirement funds sailed along their glide paths toward a predetermined horizon. Those nearing retirement suffered massive losses, in part because the funds were (very reasonably) designed to maximize income by remaining fairly aggressive well into the retirement phase.

Outcome-Focused

None of this should detract from the work Intel has done to improve retirement outcomes for their employees. Not all of that work was on plan design. The company also went to considerable effort to sell the changes to employees, even to the point of “senior managers talking to workers on night shifts,” which again points to the critical behavioral aspects of investing.

With the plan and communication campaign fully in place, Intel reports that “more than 70% of participants now have age-appropriate allocations” of assets. For a plan without managed accounts, that’s an impressive outcome indeed.

Is Intel's plan a model for others? As always, your comments are welcome.