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Pay Close Attention to So-Called
"Default" Investments
One of the provisions of the Pension Protection Act of 2006
was to allow companies to automatically enroll their employees
in their companies' 401(k) plans, but it wasn't until last
October that companies got guidance on the categories of
investments they had to choose for their workers' contributions.
The decision contained a controversial provision. The Labor
Department decided to prohibit stable-value funds or guaranteed
investment contracts (GICs) from the choices, because many
experts find them too conservative for younger investors.
Instead, companies can now offer balanced mutual funds among
their QDIAs (Qualified Default Investment Alternatives) as well
as target and lifecycle funds. Balanced funds create an
assortment of investments that fit the group of employees as a
whole, while target or lifecycle funds contain specific mixtures
of investments targeted to an investor's age or retirement date.
What's also important to know is that employers won't be
liable for employees' money lost while invested in a QDIA, but
they'll be responsible for doing the due diligence to select the
investments, for monitoring the investments' performance and for
deciding whether to keep or jettison those investments.
So does that mean that you can comfortably rely on default
investments for your entire retirement strategy? No.
Target investments specifically have become very popular.
Money has been gushing into these funds, according to the
Investment Company Institute. By yearend 2006, this particular
category of funds held $114.3 billion in assets, up from only
$12.3 billion in 2001. Why the demand? In part such funds have
been positioned as "no-brainer" investments for
individuals without the time, inclination or knowledge to choose
investments for themselves. 401(k) plan architect Ted Benna was
quoted earlier this year as saying that within 5-10 years, more
than 75 percent of 401(k) plan assets could be invested in
target funds.
A trained financial expert such as a Certified Financial
Planner™ professional can help individuals meet specific goals
in retirement that aren't addressed by these one-size-fits-all
plans. For instance, some critics say life-expectancy issues are
not adequately addressed in target-date plans, and they
definitely don't address scenarios in which you plan to work in
retirement or spend your assets in unconventional ways. Also,
some critics offer that many people may underfund such plans
without realizing the correct amounts they should invest to meet
their goal. A planner's job is to help advise individuals on an
ongoing basis about meeting such goals.
That said, how should you evaluate a target-date fund? Here
are some questions you should ask:
Do you know how much money you'll need to retire? This
is one of the questions you should start with based on your age
and the vision of retirement you have. It is one thing to invest
in a fund that promises consistent growth until your retirement
date, but what if you need more growth? What if there are
specific tax and spending issues that might interfere with
putting the right amount of money into such funds each year?
This is why individual advice makes sense. A mutual fund can't
ask you what your goals are, nor can it make sure you're
investing enough.
How did your employer select the funds it's offering?
Obviously, most employers want to make the right fund choices
for employees, but just because they're offering target funds
doesn't mean they're offering the right target funds for you and
your needs. Keep in mind that most fund choices offered to
companies are heavily marketed and might not be the cheapest or
most efficient investment choices out there. Always check the
Morningstar rating of any fund your 401(k) invests in.
What if you leave your job and take your 401(k) with you?
What happens to your targeted investment plan then? Obviously
you'll roll over these assets into another tax-advantaged
retirement plan, but what will happen to your annual retirement
savings strategy at that point? Always ask.
What are you paying for a targeted fund? Granted, the
investment choices are being made for you, but what are you
paying for those choices? Often, these funds are constructed
based on a fund-of-funds structure that layers a fee on top of
the fees incurred by the individual funds. Always understand the
fee structure of any fund you invest in.
January 2008 — This column is produced by the Financial
Planning Association, the membership organization for the
financial planning community, and is provided by Don McCarty of
Financial Decision Partners, a local member of the FPA.
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