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Key Takeaways
- Managed account qualified default investment alternatives (QDIAs) in 401(k) plans are fundamentally flawed because advisors and money managers can’t truly manage assets for plan participants who can’t engage.
- Current managed QDIAs typically use recordkeeper wealth data to make a risk decision, confusing capacity (ability to take risk) with tolerance (willingness to take risk).
- A more effective approach differentiates between self-directed and defaulted participants by providing a truly managed account to each self-directed participant while tailoring a custom target-date fund (TDF) QDIA for all defaulted participants.
- The TDF industry’s oligopoly drives gimmicks like managed QDIA accounts, which only pretend to deliver genuine personalization.
Why Default Managed Accounts Can’t Live Up to Their Name
Last year, Advisor Perspectives published "Why the Difference Between Risk Capacity and Risk Tolerance in Retirement Investing Matters," highlighting the flaws in personalized target-date accounts. Since then, managed accounts — the other flavor of personalization — have surged in popularity, prompting me to write this follow-up. Everyone wants personalization because investing is personal, but plan participants want the real deal — not marketing spin.
A managed account is an investment service where a financial expert oversees assets on your behalf, where you set the financial goals and risk level, and the manager makes daily choices to meet your goals. [1, 2, 3, 4]
Serious confusion has arisen regarding the term “managed account” in 401(k) plans, especially as it relates to qualified default investment alternatives (QDIAs). The Pension Protection Act of 2006 specifies that a managed account can be used as a QDIA. However, keep in mind that a QDIA is for participants who default because they don’t know what they want or refuse to discuss their risk. They trust their employer to figure it out, so you have no way of knowing their financial goals and risk levels.
The Act Makes a Mistake That Has Led to Serious Confusion.
An account can be managed for non-defaulted/self-directed participants because they do want to meet with an advisor for individualized help. However, as mentioned above, it can’t be managed for defaulted participants. Confusingly, there are two kinds of managed accounts — one that’s actually “managed” for self-directed individuals, and another that’s unmanaged for QDIAs (yes, an unmanaged managed account).
Unmanaged QDIA Managed Accounts
This type of managed account attempts to substitute recordkeeper wealth data for investor preferences, assuming that because the wealthy can “afford” more risk they want to take more risk.
This approach confuses risk capacity with risk tolerance/preference. Just because someone can afford risk (capacity), doesn’t mean they want to take more (tolerance). High-net-worth investors often prioritize capital preservation over growth. Conversely, investors with lower net worth may have higher risk tolerance because aggressive growth offers a path to meaningful wealth accumulation.
Managed accounts and personalized target-date accounts that use recordkeeper data rather than investor input are not truly managed — at least not in the literal sense. They rely on wealth rather than true investor preferences, and those faulty inferences lead to bad risk decisions.
A Better Approach to Managed Accounts
A more sensible managed account is designed for investors who do want to work with an advisor — the self-directed participants — and to provide a suite of risk-based glidepaths from which to choose. These individuals tell you their risk preference and their expected retirement date, and you do the rest.
For those who have defaulted into a QDIA, the 401(k) sponsor designs a unique custom target-date fund (TDF) QDIA for all, conforming to DOL guidance by matching the TDF glidepath to the workforce demographics. Specifically, the sponsor chooses the appropriate risk for the QDIA by blending Conservative-Moderate-Growth glidepaths, plus setting a retirement age for all who default.
The TDF industry is an oligopoly where four firms dominate more than 75% of the $5 trillion market. Competitors that are desperate for market share have turned to “managed” QDIA accounts — a gimmick masquerading as personalization.
More articles by Ron Surz:
Ron Surz is president of Target Date Solutions, developer of the patented Safe Landing Glide Path and Soteria personalized target date accounts. He is also co-host of the Baby Boomer Investing Show. Surz’s passion is helping his fellow baby boomers at this critical time in their lives when they are relying on their lifetime savings to support a retirement with dignity, so he wrote a book, “Baby Boomer Investing in the Perilous 2020s,” and he provides a financial educational curriculum.
For anyone who relies on TDFs — or advises those who do — Surz’s new book is a must-read guide to understanding the risks, solutions, and future of a secure retirement.
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Advisor Perspectives welcomes guest contributions. The views presented here do not necessarily represent those of Advisor Perspectives.