Designing Retirement Plans For Different Types of Investors

Posted on Wednesday, July 26, 2017

If your company sponsors a 401(k) or other retirement plan that requires participants to make investment choices, you face a challenge when deciding on the investment line-up for the plans. In most workplaces, plan participants have different degrees of investment expertise and interest. Some want to become involved in great detail with all aspects of the investment process -- such as researching the particular investments in a mutual  fund, analyzing how fund choices meet their risk tolerance, and reallocating investment choices on a regular basis to maintain the desired mix. Other participants are not so inclined. They may lack the knowledge, time, or interest needed to attend to their retirement plan investment portfolios.

Furthermore, regardless of the level of expertise or interest, investment personalities vary from person to person. For example, some people are comfortable with risk while others are not; some people need to be more "in control" than others.

Given these differences, how can you construct the appropriate investment menu for the plan your company sponsors? Essentially, the choices should recognize that participant-investors cover a spectrum ranging from those who are self-sufficient to those who would rather have someone else make investment decisions for them -- with most participants falling somewhere in between.

The Options

At first glance, it might seem that a plan must have a large number of fund choices to meet all employee needs. However, that's not the case. In fact, too many fund choices can overwhelm participants (and not necessarily offer more opportunity for them to diversify). Through a careful selection of a manageable number of fund options, plan sponsors should be able to offer a menu of options to satisfy all participant-investors.

Managed or lifestyle funds (also sometimes called life cycle or pre-mixed funds) can be useful in this regard. These professionally managed funds offer pre-mixed portfolios of investments for a range of investor types.

Lifestyle funds are usually characterized by degree of risk or maturity of investor. Those keyed to risk might be categorized as aggressive, moderate, or conservative. Those keyed to investor maturity might be categorized by age, or by the number of years to retirement. This latter group is usually offered in 10-year increments, and the investments in the fund are automatically reallocated as the targeted group ages. For example, consider a fund geared toward participants who anticipate retiring around the year 2040. When the targeted investor group is still young, the fund would be invested primarily in equities, focusing on asset growth. As the years pass, fund managers continually reallocate the investments in the fund so that by the time the year 2040 approaches, the mix is focused more on preservation than growth.
In contrast to a lifestyle fund, a managed fund labeled by degree of risk is not automatically reallocated as time passes (although it would be reallocated to maintain the desired degree of risk). It is up to the individual investor to move his or her assets into a fund that takes greater or less investment risk, if personal circumstances indicate that a different degree of risk is appropriate (such as aging or a change in financial situation). Similarly, a managed fund that is labeled by targeted investor age (rather than expected year of retirement) is typically not automatically remixed on account of the passage of time. It is usually up to investors to move assets to different investments when they reach a new targeted age group.

Pre-mixed funds address the needs of participants who do not have the time, inclination, or expertise to appropriately allocate their plan investments. Plans that offer lifestyle funds typically also offer other, non-pre-mixed funds. This allows participants who want to be more actively involved in their investments to do so.

Offering a good selection of investment funds -- coupled with education and concerning plan investment offerings -- goes a long way toward ensuring your company's retirement plan is designed for different investor types.

Posted in Employee Benefit Plan

Disclaimer: The information contained in Dulin, Ward & DeWald’s blog is provided for general educational purposes only and should not be construed as financial or legal advice on any subject matter. Before taking any action based on this information, we strongly encourage you to consult competent legal, accounting or other professional advice about your specific situation. Questions on blog posts may be submitted to your DWD representative.

"Carrie does an excellent job every year presenting the audit to the Board of Directors.  She clearly communicates relevant information and action items we can take as a Board.  Through her…"

Heather Schoegler, Board Member of Ronald McDonald House