How Digital Players Are Digging Into the 401(k) Space
When Paul Nigrelli, CFO of Equilend, a New York-based technology company that services the banking industry, hosted a financial education meeting for his employees a couple of years ago, he was “very surprised” at the lack of financial knowledge his employees had. Many employees had their retirement funds sitting in a money market account or in a single mutual fund or they hadn’t revisited their asset allocation in years.
Nigrelli felt an obligation to do something to help, but also knew that whatever he chose to do, it had to be simple. “Employees are intimidated by brokers and investment advisers and nobody wants to spend that kind of money,” he says.
After doing some research, Nigrelli hired Financial Guard, an Ohio-based robo advisory firm that’s been working in the corporate retirement plan space since 2014. He didn’t have to change Equilend’s 401(k) record-keeper or do anything other than make the service available to his employees. Employees sign up, their 401(k) investments are already in the system and Financial Guard grades their portfolio and then gives them advice on how to rebalance to achieve an A grade.
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“The fact that you can go to a website, put your information in and it runs an algorithm and gives you some options and ideas, I thought was quite beneficial,” says Nigrelli, who estimates that approximately 40 of Equilend’s 65 employees signed up with Financial Guard.
Equilend pays for employees to have access to Financial Guard’s service as an employee benefit, at a cost of about $5,000 a year. “It’s pretty much a no-brainer from a cost perspective,” says Nigrelli.
Financial Guard is just one of several so-called robo advisors that have entered the 401(k) space in recent years. Others include Betterment for Business (launching in January), Blooom and Captain401. They all claim they can workers into better investments and they say they can do it more cheaply than managed account services offered by traditional record-keepers.
“I think we're at a tipping point where the industry's going to transform a little bit, says Kevin Pohmer, CEO of Financial Guard, which has 40 corporate clients ranging in size from 50 to 1,000 employees.
But nothing in the 401(k) plan market changes overnight and some caution that while robo advisors may have a valuable role to play in helping prepare employees for retirement, employers need to do their due diligence – as they would with any other 401(k) vendor.
AUTOMATED OR MANAGED?
“What we typically hear is that the definition of a robo advisor is this computer-generated model that’s going to help plan participants,” says Marina Edwards, senior consultant in the benefits advisory and compliance practice with consulting firm Towers Watson. “I’m not seeing it showing up or appearing in 401(k) plans other than [as] managed accounts.”
Call center and website tools are the standard ways employees get investment advice in their 401(k) plans today. But they appeal primarily to highly engaged employees, the do-it-yourself investors. Those employees who want to be more hands-off and have someone do it for them can use a managed account service, but only if it’s an option their employer offers. And there’s an additional fee, usually asset-based.
Managed accounts have been long been promoted as the best way for employees to generate better rates of return. Indeed, there have been surveys that show that employees in managed accounts have greater rates of return over time, says Edwards. Still, only 47% of employers offer a managed account service, according to Aon Hewitt research, and participant uptake is usually pretty low.
“I think the uptake [of managed accounts] has been low, because [employees] have to opt in and [they] have to pay additional fees on top of fees [they’re] already paying for everything else and we don't have either of those issues,” says Cynthia Loh, head of Betterment for Business.
Betterment, which launched in 2010, announced in September it would be pursuing the 401(k) market. The retail side of the business has $3 billion in assets under management and 115,000 customer accounts. (The firm has brought on Upside co-founder Tom Kimberly to be general manager of Betterment Institutional.)
Under Betterment’s model, the company acts as the plan’s record-keeper and investment adviser. The firm is an SEC registered investment adviser. Betterment’s 401(k) service will default participants into a managed account of stocks and bonds through exchange-traded funds. “Most record-keeping systems cannot handle ETF trading, but ours clearly can,” says Loh. “The big difference is that we’re auto-enrolling our participants into a managed account – essentially that is our QDIA [qualified default investment account.]”
The managed account is defaulted to whatever mix of stocks and bonds “we think is most appropriate for a person based on their birth date,” says Loh. “Then, as they tell us more information, we can get better at that process.”
Pricing for plan sponsors ranges from 10-60 basis points, depending on plan assets. “We’re writing your investment policy statement for you and really taking on that burden of fund selection for our plan sponsor,” she says.
'FEES AREN'T THE ENEMY'
Roger Lee, CEO of Captain401, a robo advisory firm based in San Francisco, believes robo advisors present a real opportunity to target a market long underserved by traditional 401(k) plan vendors: small businesses.
“I want to get to a point where, in five years, it’s as common for a small business to have a 401(k) as it is for a large company,” he says. “So many people don’t have access to a 401(k) today. That needs to change.”
Captain401 is a 401(k) record-keeper and an RIA. Its fee structure is based on assets under management and averages 60 bps, which includes custodian fees, investment fund fees and record-keeping fees.
“We use technology to automate and offload all of that set-up and administrative work so that any business – even a small one – can get a 401(k) without having to have dedicated resources to run it,” he says, adding that the same thing holds true for small businesses that already have a 401(k) plan. “Oftentimes they're stuck, because they're a small business and they don't have much leverage,” he says. “They're stuck in a bad plan either because that plan has really high fees or it requires the employer to do a lot of administration.”
Blooom, another robo advisory firm, analyzes a plan participant’s 401(k) investment options and recommends a portfolio based on the investments that are already in the plan. “We have no desire to be involved in any way, shape, or form with changing the 401(k) provider, because it ultimately doesn't matter to us,” says Chris Costello, founder and CEO of Blooom, which is also an RIA.
Blooom charges participants a flat rate: $1 per month for portfolios under $20,000 and $15 per month for portfolios over $20,000.
“Fees aren't always the enemy. The bigger enemy is no help,” says Costello. “That's the problem we've got in this country – not fees, it's no help.”
More plans are changing their 401(k) fee structure, moving away from asset-based fees and revenue-sharing to a flat per-head fee, driven by regulatory pressures and a fiduciary duty to ensure that plan fees are reasonable.
“The rash of these fee lawsuits have driven plan sponsors to re-evaluate and get out of asset-based fees and move to the flat per-head fee that ties the fees to the services so that they're more closely aligned,” says Towers Watson’s Marina Edwards.
Getting out of an asset-based fee structure, she says, is usually pretty straightforward and requires some negotiation with the record-keeper about what the new fee structure should be. However, she cautions, it’s not a decision to be taken lightly. “There needs to be proper process and research and exploration that should be done and documented by the employer that shows how they've weighed the pros and cons of the different fee structures and how their resulting fee structure supports their fiduciary duty that it's the right thing for the participant.”
In addition to advice, robo advisors have the potential to change the way retirement plan education is delivered to employees.
“The traditional approach to education has been to dump a ton of information onto the employee without much regard for how employees like to really consume that information,” says Captain401’s Lee. “We don’t try to overwhelm them with jargon or investing information or numbers. We present everything in an easy-to-understand way, in plain English and with visualizations. I think it’s a different approach to making sure that the 401(k)s feel accessible for the first time to these employees.”
Adds Costello: “The antithesis of what Blooom is doing would be sending all of our clients an email letting them know what just happened in the Federal Reserve open market committee meeting, which 99% of Americans don’t care about.”
CME Federal Credit Union, a credit union in central Ohio with about 70 employees, started using Financial Guard just over a year ago. Ginger Yonak, vice president of human resources, says one of the things she frequently hears employees say they like about Financial Guard is the continuing education aspect of the service.
“They send out market updates on a regular basis,” she says. “They might take some concerning economic condition and break it down into plain English so you know exactly how the market conditions may or may not affect your portfolio.”
In addition to offering the service as an employee benefit, the credit union offers it at a discount to its 28,000 members across central Ohio.
“Our back-end is building out a custom financial literacy plan that’s pushed to [employees] based on where their starting point is,” says Pohmer. “It usually takes three to five minutes [to set up] and they’re done. Then everything is pushed to them through their smartphone or tablet.”
And for those employees who feel more comfortable speaking with a live person, robo-advisers do have client service teams. “I think the thing about Betterment that people actually don't really know is that we have a customer success team that is around seven days a week answering emails, as well as phone calls, and we really strive to excel at that,” says Loh. Blooom also has an “Ask a CFP” feature on its website.
As with any move related to 401(k) plans, employers need to do their due diligence. “You have to look at each robo advisor and say, ‘Is this different than what exists today or is it just hype and marketing?’” says Pohmer.