Defined contribution plans have been hammered by dropping equity markets, and this chain of losses has caused a ripple effect throughout the fund management industry.
Most notably, target-date funds declined an average of 17% in 2008, and even 2010 funds, which are supposed to be the most conservative, declined in value anywhere from 3.5% to 41.3%.
Clearly, money managers will need to come up with new retirement options, such as target-date plans with guaranteed income wrappers, to help investors save more and restore confidence in the system.
"Huge losses have taken place," said Luis Fleites, vice president and director of retirement markets at the Boston-based Financial Research Corp. "In the past eight years, we've had two dramatic market declines. These declines aren't supposed to happen very often, but obviously they're taking place."
Like the 100-year flood that hits multiple times in a single decade, the market's shocking losses of late have caused everyone from investors, fund managers, recordkeepers and Congressmen to question whether current defined contribution plans provide enough protection on the downside to still be a reliable retirement option.
"Investors need to maintain a level of growth in their portfolios," Fleites said. "A certificate of deposit is not going to get the average worker the nest egg they're going to need for retirement. They need market growth, but they can't afford the danger of volatility near retirement."
Fleites said 401(k) participants saw losses between 20% and 30% in the period between 2000 and 2002, and could see losses greater than the broad market decline of 39% in 2008, if the recession lingers.
"How much risk should someone about to retire be taking?" Fleites asked. "Can 401(k) participants afford to do that and still keep their retirement goals? Should there be more guaranteed options available?"
Sophisticated investors and portfolio managers know to make timely adjustments during booms and busts in order to preserve and grow capital, but average investors aren't nearly that savvy. The buy-and-hold, set-it-and-forget-it strategies that have worked for decades have punished sedentary investors and shaken their trust in the system.
Target-Data Funds
Thankfully, the system isn't shattered. There is hope for managers and investors in target-date funds, particularly if the investor can get into the right fund for them. That's where good advice comes into play.
Fleites said the industry has made big strides in its efforts to improve communication and investor education, but there is still a lot of work to be done, particularly in the proper usage of advice. Advice needs to improve significantly, he said.
The asset allocation and performance of target-date funds can vary dramatically, even among funds with the same target date, as proven by the performance of 2010 funds last year. One firm's 2010 fund may be appropriate for some investors, but not for others, he said.
"Target-date funds are not customized, and they don't meet everybody's needs," Fleites warned.
Many investors still aren't sure how to pick an appropriate target-date fund, and some common mistakes are to put an equal percentage of their portfolio into each target-date fund offered or to put their money in a 2010 fund when they won't be retiring for 20 years, just because they don't want risk. A good adviser can help investors get into the most appropriate plan.
"There really is a difference between target-date plans," said Chris Brown, a principal at Sway Research LLC. "Some are designed to get people to retirement, while others are designed to last the full lifecycle."
Auto Enrollment
Another critical key to better preparing investors for retirement is automatic enrollment. If plan sponsors can automatically enroll new employees into an appropriate target-date fund, while still giving them the option to change their allocation or opt out entirely, they can take advantage of the inertia factor that causes so many investors to just stay put in whatever plan they started out in.
"So far, auto enrollment's impact has been small, but gatekeepers say they expect pretty substantial increases over time," Brown said. "Auto enrollment might increase annual flows by 15% to 20%. If a plan had a 70% enrollment without auto enroll, now it's close to 100%. There's more money coming in and more assets to manage."
Automatically putting employees in a plan is a very positive step in the right direction, Fleites said. Combining auto enroll with deferral increases is also critical, he said. In fact, a lot of good ideas can be added to target-date funds, such as a guaranteed income component to protect retirees during market losses.
"Target-date funds are perceived as a safe harbor, and it would make sense to have a guarantee there," he said. "The timing is perfect and the concept is very appealing, but the implementation will be slow. It will take a little time for that concept to filter through and be accepted."
Many companies, including UBS, DWS Investments and Bernstein Global Wealth Management, have already adopted products like this.
"The higher danger is on the legislative side," Fleites said. "I'm talking about changes done quickly to address perceived risk, and knee-jerk reactions to try and solve these problems that can end up being counterproductive.
"Everything done for 401(k)s has been an improvement, but it's still not a perfect structure," he continued. "I'm afraid a lot of good will be ignored."
Money managers depend on investor prosperity for their own success, and when investors suffer huge losses, managers get pinched.
"It's tough to gather assets right now," Brown said. "Most firms didn't meet their goals last year. The investment-only opportunity has really dried up.
"It's easy to spread yourself too thin in this space," he added. "2009 budgets have been cut dramatically. Firms are cutting back on conference attendance and cutting back on research.
"The biggest challenges facing managers are maintaining profit margins and the downward pressure on management fees," Brown said. "Record keepers, plan sponsors and consultants are all putting pressure on managers to manage for less. If another manager can manage the same asset class for a lower cost, they'll consider making the switch."
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