According to a survey taken every three years by Callan Associates, the number of investment choices offered by retirement plans has actually gone down, from an average of 20 in 2001 to 16. That’s the first downturn ever, as far as I know, and an encouraging sign that with enough evidence, the industry can indeed come to its senses about what really works for plan participants.
Even more interesting is that nearly three fourths of plan sponsors (74%) now include so-called lifecycle or lifestyle funds among these choices. These “autopilot” funds offer built-in asset allocation that corresponds to the needs of individual participants, at least roughly. This is another step in the right direction.
Most of these funds are still risk-based, built around somewhat arbitrary levels of risk tolerance. But an increasing number of funds – up from 21% to 41%, according to the survey – are now structured according to time horizon instead. Each of these “target-date” funds is built for investors who plan to retire at a particular time; as that day approaches, fund managers adjust asset allocation and risk to track the changing needs of investors approaching retirement.
Good news, but.
This is good news. But it’s not yet great news.
While it’s exciting that plan sponsors are turning away from the Baskin-Robbins model (31 flavors of investment choices, plus toppings!), even time-based lifecycle funds are not going to ensure a well-balanced financial diet for many investors. Here’s why.
- They aren't always used properly. These funds are designed for the investor’s entire plan balance, or most of it. Unfortunately, many participants treat the lifecycle option like just another fund, and direct a small slice of their money into it (the problem of too much choice, redux.) This completely defeats the purpose – and depending on the rest of the portfolio, may actually make matters worse. Apparently the message to “Diversify!” has finally sunk in, with some ironic consequences.
- They're not the same as managed accounts. Technically, lifecycle fund investors simply own shares of one fund instead of a portfolio of actual investments. If the fund categories are quite broad (and they often are), it’s like choosing clothes in small, medium, or large: better than one-size-fits-all, but nowhere near custom-tailored. Another potential problem is that they’re only as good as the underlying component funds. These are usually all drawn from the same fund family or company, and some may be low-performers, expensive, or both.
- They're not an investment strategy. Even a quality lifecycle fund, used correctly, is no substitute for real financial planning, because it doesn’t tell investors how much to save. Savings rate is a hugely important factor – especially for participants who don’t begin to save seriously for retirement until somewhere in mid-career. Also, no investment fund can account for the whole assortment of outside assets, other plans or pensions, college costs, and so forth that make up the financial lives of real people.
What price financial security?
One aspect of lifecycle funds that’s still a bit unclear is their cost. Some funds have a management fee on top of the costs of the component funds; some don’t. Some experts feel these funds are a great value because they offer hassle-free asset allocation on the cheap. Others content that a managed account, picking and choosing from low-cost funds, can give much better value for the same money, or less. And in any case, mutual fund fees have been on a downward trend lately.
I’m not overly concerned about cost issues, especially because they’re sure to keep fluctuating as the industry evolves. However this mini-debate turns out, let’s keep an eye on what we’re trying to accomplish for plan investors in the long term. To paraphrase that ubiquitous credit card ad:
- Time-based lifecycle fund costs: A few basis points.
- Managed account fees: A few basis points, more or less.
- Saving enough money to retire comfortably: Priceless.