Nudging Participants to Rebalance Portfolios

For those plans where participants are left to make investment decisions on their own, experts agree, it is critically important for advisers to educate them about the proper diversification.

Art by Dalbert Vilarino

Retirement plan advisers may agree that pairing automatic enrollment with a target-date fund (TDF) as the default investment is the ideal way to ensure that participants’ assets are properly invested at the outset and continue to be so throughout the years. But the 2018 PLANSPONSOR Defined Contribution Benchmarking Report shows that less than half, 46.3%, of employers use automatic enrollment.

For those plans where participants are left to make investment decisions on their own, experts agree, it is critically important for advisers to educate them about the proper diversification.

“We have done studies on rebalancing and we have found that the first thing you have to get right is asset allocation because that drives 90% of returns,” says Mike Swann, client portfolio manager, defined contribution team at SEI Investments in Oaks, Pennsylvania.  “That is critically important and needs to be tied to your goal.”

This is why SEI strongly recommends target-date funds (TDFs) and automatic enrollment to the plans it serves, Swann says. To get participants to select an asset allocation that is right for their age and risk tolerance and to do periodic rebalancing to ensure the portfolio is tied to the participants’ original goals is nearly impossible, Swann says. He notes that the National Association of Retirement Plan Participants’ recent participant engagement study found that less than half of participants look at their retirement plan website or call into the call center.

“Use participants’ inertia to their advantage by embracing automatic enrollment, auto escalation and TDFs,” Swann recommends. “TDFs automatically rebalance over years, and some even take participants through retirement. If an employer has a rich plan, custom TDFs are a great way to get there, and have become more cost-effective.”

For those plans without automatic enrollment and a TDF, balanced fund or managed account as the qualified default investment alternative (QDIA), it is incumbent on the adviser to help each participant determine what asset allocation is right for them, says Josh Sailar, a certified financial planner with Miracle Mile Advisors in Los Angeles. That doesn’t necessarily mean a 60/40 portfolio split between equities and fixed income, he says.

Rather, “it’s an individual decision that depends on how much you are saving overall, how much you are deferring into the plan, how long you have to save and when you are going to need the money,” Sailar says. Generally speaking, however, the longer the savings horizon, the greater the exposure to equities a participant should have, he adds. “For shorter periods of time, participants should dial back their equity exposure.”

Ken Catanella, managing director, wealth management at UBS in Philadelphia, agrees: “The need to set an asset allocation to meet one’s aging and, thus, becoming more risk-averse over time is at the core of a disciplined rebalancing and asset allocation program. Every client is different in seeking their financial goals. Considerations such as age, risk tolerance, financial status and time horizons all, together, make each individual’s situation very different.”

For these very reasons, Wintrust Wealth Management sits down with each participant to help him determine what should be his individual asset allocation, says Dan Peluse, director of retirement plan services at the practice, based in Chicago. “The allocation should be age- and risk-appropriate based on his goals,” Peluse says. “This is an individual discussion we have with participants, to review their individual circumstances.”

Once the proper asset allocations are determined, Miracle Mile Advisors educates participants about the need to periodically rebalance portfolios to rein them back into meeting initial goals, Sailar says. “Participants need to make sure the risk they want to take is actually the risk they are taking,” he says. “Certain asset classes can become over- or under-weight over time.”

Amr Hanafy, research associate at BCA Research in New York, says, “Rebalancing is definitely recommended for all investors, perhaps more so for retirement plan participants than others, as they are more likely to be concerned with capital preservation than capital appreciation.”

While a portfolio that is not rebalanced will have a greater allocation to equities during a bull market and, therefore, outperform a rebalanced portfolio, “all rebalanced portfolios outperformed an unbalanced portfolio during periods leading up to market corrections and recessions,” Hanafy says, citing a BCA Research study which looked at three main rebalancing scenarios of a simple 60/40 portfolio since 1973.

Rebalancing becomes even more critical once an investor reaches age 40 or 45, says Tina Wilson, head of investment solutions innovation at MassMutual in Enfield, Connecticut. “There are two main components to retirement plans: returns and the risk you take,” Wilson says. “By not rebalancing his portfolio, a participant could inadvertently take on too much risk, which would expose him to a market correction. This is important because, statistically, as participants reach age 40 to 45, how much risk they take on is far more important than how much they save. When you are young, the most important thing is how much you save.”

There are two main approaches a participant could take to rebalancing, Wilson says. One is time-based, and could be done on a quarterly, semi-annual or annual basis and be set up automatically through the recordkeeper. The second would be based on style drift, but because that would require participants to be proactive, Wilson views the former as preferable.

“For those participants who are engaged and working with an adviser, the percentage of portfolio methodology can be successful,” she says.