PA: What are some key challenges you see employers have in retirement strategies for their participants?
Scott Wittman: When saving for retirement, there are lots of different risks you have to balance. For instance, you could completely eliminate market risk in your savings, but that would cause your longevity risk to skyrocket. It’s important to have a very balanced approach. Remember that we moved as a society from defined benefit (DB) to defined contribution (DC), and in defined benefit plans the decisions are all made by professionals. In defined contribution, the ultimate decisionmaker is the participant. So, you can design the best plan in the world, but if participants can’t use it effectively, it’s not going to meet your goals as an employer.
PA: As far as trends in retirement investing, what do you think is happening now and what will change in the future? How do you see those trends in qualified default investment alternatives (QDIAs)?
Wittman: I think the biggest trend is sponsor interest in re-enrollment, but a lot of plan sponsors are reluctant because they’re concerned about negative feedback. I was on a panel earlier this year with a sponsor that had that concern. They did the re-enrollment anyway. Of about 1,500 participants in their plan, he said exactly nine people called and six of those called to find out their PIN. Employees are very accepting of re-enrollment, and it dramatically improves the health of plans. Our 2015 research found that 71% of participants ages 25–54 feel employers should do a re-enrollment.*
PA: How have target-date funds (TDFs) performed?
Wittman: Target-date funds have performed almost amazingly well since they became a QDIA. Financial Engines had a study a while back that separated participants into “do it yourself” and “some assistance” participants, and “some assistance” included target-dates, managed accounts and online assistance.
What they found was stunning. The do-it-yourselfers underperformed the some-assistance people by 3% a year. There’s also an increasing amount of literature that shows participants in target-date funds are more likely to remain in the markets than if they invest in individual funds.
If you think about customization, there are three questions you need to ask yourself. First, do you need it? I would argue that there’s an age dimension to that. Most 25-year-olds have very little assets and relatively homogeneous goals; when you get to 65, you probably need a customized solution.
Second, do you have enough information to customize at a level that’s effective? If you customize at the level of the plan demographics, it’s not that useful for the individual participants, because it will only fit a person who’s near that average. Imagine if American Century wanted to provide customized clothes then made the clothes to the average of the employees’ measurements. Those clothes would fit virtually no one; the same thing is true with a plan.
Third, is it worth the additional expenditure? It’s hard for plan sponsors to justify 10 or 20 additional basis points (bps) of fees to get to a customized solution.
PA: As an investment adviser, what would you look at to show your client that the TDFs you recommended are meeting the measurement criteria?
Wittman: We’ve done a lot of work on this. The amount of wealth investors have varies enormously over time. When you’re 25, you have no money; when you’re 65, a lot of your net worth is tied up in your fund. So, if you’re going to come up with a number to evaluate a suite of target-date funds, it’s important to wealth-weight it because those funds need to do well when people have a lot of money at risk, and they need a good return at that time.
We would also focus on the Sharpe ratio or some type of risk-adjusted performance to see how much return you got for the amount of risk you had to bear. In asset allocation, you can always get a higher return—you just need to take more risk. If you don’t risk-adjust returns, you won’t find out if a manager or product is truly adding value or just adding risk.
PA: What advice would you give advisers when participants select multiple target-date funds or a target-date fund as a portion of their portfolio?
Wittman: Multiple target-date funds—please don’t do that. Part of the real power in target-date funds is their simplicity from the participant standpoint. So, if you have participants who have multiple target-dates, I don’t think that works. Sponsors may think they are giving people a choice; turns out, when it comes to target-date funds, less choice is better for participants.
*Source: American Century Investments’ “Who’s in the Driver’s Seat?” Participant Research 2015
The opinions expressed are those of American Century Investments (or the fund manager) and are no guarantee of the future performance of any American Century Investments fund. This information is for educational purposes only and is not intended as investment advice.