WASHINGTON - The general consensus among financial experts is that target-date funds are better suited for the majority of 401(k) investors than money market funds. Only problem is, the passive participant seems to have little interest in making changes to their plan, especially if they were automatically enrolled into it.

"Too much choice causes people to freeze up," said Ann Combs, a principal at The Vanguard Group, speaking at the Investment Company Institute's 50th Annual General Membership Meeting during a breakout session titled "Seismic Shifts in DC Plan Investing."

"Some of these plans have hundreds of options," she added.

For a long time, money market funds were the only allowed default option for auto enrollment. The Pension Protection Act of 2006 created new, safe harbor rules that removed several impediments to auto enrollment-allowing lifecycle, target-date, balanced fund and professionally managed accounts as qualified default investment alternatives. While 401(k) plan administrators have been anxious to offer target-date funds, at least as an option on the menu of choices, convincing 401(k) plan participants to make the switch seems to be going nowhere, Combs said.

Tectonic Plates

The earth's tectonic plates also move slowly, but sometimes seismic shifts occur that jolt the entire landscape. Defined contribution 401(k) plans may be in line for such a jolt.

"The best thing you can do for participants is to hit refresh, and put everybody into a target-date fund," said Steven Lipper, director of retirement marketing for Lord, Abbett & Co. LLC.

As long as a firm gives enough advance notice about the switch and offers participants the option to change their asset allocation afterward, the refresh should go smoothly, added Joseph Healy, director of institutional investments at AllianceBernstein. Low investor inertia should keep most participants in the new plan, he said, and from then on, the target-date plan can be the default for new participants.

Scott Gilmour, senior vice president of investment services/investment product management for Fidelity Investments, said he has seen a change in how people are using Fidelity's Freedom Funds.

"Our Freedom Funds have seen high adoption for a long time, but now lifecycle funds are the first stop," Gilmour said. "People are buying not as a position, but as a program. Ninety percent of our plans have a lifecycle option. For many investors, the most important decision today is to believe in the philosophy of how a fund is being managed."

Fidelity is already seeing some dramatic changes in the allocation of workplace retirement plans. Blended options have grown from 9.3% of overall DC assets in December 2001 to 15.9% as of March 2008. International equity has also grown in popularity from 3.1% of assets in 2001 to 10.0% this year. Investment in domestic equity and company stock has dropped dramatically during the same time period, as well as the use of short-term and stable-value options in DC plans.

Lipper said he is seeing a greater penetration of commingled plans, particularly in this environment of heightened sensitivity to fees.

"Auto enrollment may end up driving the bimodal distribution of plan rates," Lipper said.

Element of Paternalism

The fund industry may need to take on an element of paternalism to better face the challenges of aging participants, Combs said. Longevity insurance, which is only collected once you reach age 85, can make a lot of sense as part of the tail end of another product, she said, but you have to make it to 85 to start collecting it.

"The main issue with longevity insurance is the lump sum," Gilmour said. "You have to pay $50,000 to get $50,000 when you're 85."

Investors and retirees have very different needs. While the former group is preoccupied with saving as much as possible, the latter is consumed with trying not to use up their savings before they die.

"When people stop working, their risk aversion goes way up," Lipper said. "People still need big exposure to equities at age 65," especially if that money needs to last them 20 to 30 years or longer.

When you consider dollar/cost averaging, volatility is your friend during the accumulation period, Lipper said. "The biggest danger is inflation if you're not working."

"We want to land people with a balanced portfolio at retirement, but how do you measure this?" Gilmour asked.

"The average Gen Y investor will have eight jobs during their lifetime," he said, adding that they could have half a dozen or more separate 401(k) plans scattered around by the time they retire.

"Will investors be comfortable putting everything into one manager?" Combs asked. "Less than 1% of annuities are annuitized. People get off the annuity track as they get closer to retirement so they can get that lump sum."

Peace of Mind

Making a radical switch with people's benefits, even if it's in their best interest, can be dangerous if not done properly, Lipper said.

"If you have less than 50% participation in a plan, something else is going on there," he said. "You could have an auto enrollment revolt. People are sitting in the lunchroom asking each other, Are you in this plan? I'm not in this plan.'"

"The most important thing is to give people peace of mind and access to their funds," Healy said.

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