Anyone who has ever opened an investment account with an advisor knows that the first step in the process is gathering information to determine the risk profile and appropriate investment allocation for the client. In order to determine the appropriate asset allocation for the client, financial advisors will ask about income level, savings rate, net worth, time horizon, spending needs, investment knowledge and most importantly risk tolerance. Based on this information the advisor will recommend a tailored allocation to help the client reach their objectives while maintaining an appropriate level of risk and to help ensure clients remain invested through market downturns.
However, when it comes to retirement plans (401k, 403b, 457, etc.) and target date funds (TDFs), this process is completely different. Within retirement plans, participants are usually placed in an allocation and glidepath model that corresponds to the participant’s age, regardless of their financial condition or risk tolerance. Plan sponsors typically select the allocation and glidepath based on the average participant at the organization. This would be like fitting helmets for a football team based on the average head size of the team. Some team member’s helmets would be so loose that they would fall off their heads or spin around while others would not be able to put them on their gargantuan melons.
An ill-fitting TDF brings significantly higher consequences than an uncomfortable helmet. TDF misfit risk can lead to participants not being prepared for retirement. If a participant is not saving enough for retirement and they are placed into a conservative TDF glidepath, they likely will not achieve an adequate account balance to produce enough income replacement by retirement. Conversely, participants that have high account balances and deferral rates are exposed to unnecessary risk if placed in aggressive TDF solutions. Additionally, if a participant with a low risk tolerance is placed in an aggressive allocation, misfit risk can lead to participants pulling their money out of the market at the wrong time. In 2008, some aggressive TDFs with a 2010 target retirement date were down over 40 percent. What do you think a participant two years from retirement with a low risk tolerance would do if they saw their account balance drop 40 percent? Unfortunately, many would pull their money out at exactly the wrong time and not benefit from the recovery in the markets.
Fortunately, plan sponsors no longer have to choose one glidepath for all participants in their organization. Customized solutions that include multiple glidepaths (conservative, moderate and aggressive) are now available to enable each individual participant to select a glidepath that suits their own financial situation and risk tolerance.
For plan sponsors who are looking for an honest appraisal of their TDF options and how to get the most out of their retirement plans, look no further than Moneywise for a no-nonsense, no-obligation consultation. For plan participants looking for assistance in choosing the right allocation mix for their specific circumstances, reach out to Moneywise for a consultation.
By Justin Leland, CFP®, AIF®
Moneywise Retirement Plan Specialist + Financial Advisor
If you have any questions or would like more information, please call the Moneywise Wealth Management office: 661.847.1000 or directly email: email@example.com
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*Disclosure* The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine what is appropriate for you, consult a qualified professional.