The rise in popularity of 401(k) plans has revealed that Americans, by and large, fundamentally don’t know how to invest for retirement. People don’t save enough; they’re too conservative (or too aggressive) with their investment choices; they’re too concentrated in a particular asset (or asset class); they leave their 401(k) asset allocation as the default (typically 100% low-yielding money market accounts); they chase performance, etc.
To help people avoid these mistakes, financial companies have developed an alternative: the managed 401(k).
New research shows signs that a recent addition to some 401(k) plans — known as “managed accounts” — can provide a significant boost to workers’ retirement savings.
These programs are based on computer models that automatically manage portfolios tailored to match an investor’s age and appetite for risk. They also take into account any other retirement income they can expect — such as a pension, Social Security earnings, even a spouse’s portfolio.
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Traditionally, investors in 401(k) savings plans were responsible for making their own investment decisions. But studies have found that too many people do a poor job of it — putting their own retirement at risk. The new managed-account programs are an attempt to fix that by using sophisticated models to make investment decisions on behalf of retirement-plan participants.
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At American International Group Inc.’s AIG Valic, which has been offering managed accounts based on models developed by Morningstar Inc.’s Ibbotson Associates since 2003, the changes are translating into better returns for investors.
AIG found that for 12 months ended June 30, the average managed account gained 9.35% compared with a 5.36% return on nonmanaged accounts. In part that is because many of their clients can count on pensions, so the managed account puts more-aggressive stock holdings into their 401(k) plan.
Lauricella, Tom. “The 401(k) That Fixes Itself.” The Wall Street Journal 19 Aug 2006: B1.
Setting aside minor concerns about implemention details, this is a very good idea. These managed 401(k) plans provide, in essence, access to a professional money manager — something most Americans sorely need — while allowing the more sophisticated investor the ability to opt out.
Better defined-contribution plan defaults will do much to bulk up the physique of Americans’ scrawny retirement savings.
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