Announcement: SOA releases October 2019 Exam STAM passing candidate numbers.

401k Plans: A Sensible Approach to Investments

401(k) Plans: A Sensible Approach to Investments
by Mark Shemtob

Could it be that life style portfolios are a better fit for the majority of Americans? Evidence for that argument is presented here.

We have experienced a progression in how contributions are invested under qualified 401(k) and other defined contribution plans during the last three decades. These changes have been brought about by legislative action, the birth and evolution of the internet and the public's exposure to the financial markets through the media. I believe that this progression can be viewed in four stages; however, I am sure there are many other ways that it can be analyzed. I believe that the Stage 4 approach, as noted later in this article, needs to be seriously considered by more plan sponsors and trustees.

Stage 1: Pre 401(k) Revolution
Prior to the introduction of 401(k) plans, a single investment portfolio was established under which all plan participants were subject to the same risk/reward scenario regardless of their individual circumstances. In the case of large plans, professional investment expertise was often retained to manage the portfolio. Often these portfolios employed asset allocation techniques so as to take advantage of equity investments but to retain some stability. Smaller plans generally did not use professional services and often were invested in fixed income investments such as certificates of deposit and guaranteed investment contracts.

Stage 2: The 401(k) Revolution
With the introduction of employee funding of benefits through 401(k) arrangements, as well as advancements in computer technology, the mutual fund industry and insurance companies led the way in marketing programs comprised of investment options based on asset classes. Initially there were usually three to five choices offered. In addition, there were restrictions on the ability to make changes in the options selected by each plan participant. However, before long, some plans were offering 20 or more options and the ability to make changes daily. Depending on the selection of the investment options offered, as well as the plan sponsor's willingness to make available to the plan participants adequate investment education, this approach may or may not have been an improvement over the Stage 1 approach.

Stage 3: The Stock Market Run
Starting in the 90s, it seemed impossible to lose money in the stock market. Online access to brokerage accounts became commonplace as did low trading commissions. Hence the world of 401(k) self-directed brokerage accounts came on to the scene. This approach became popular with some smaller plans. Under these arrangements plan participants were able to invest in individual stocks and bonds in addition to thousands of mutual funds crossing over many fund families. Though some plan participants prefer the flexibility offered by this approach, many have made poor investment choices.

Stage 4: Current Trend
Over the last several years there has been a trend towards allowing each plan participant to select a single "life style portfolio" from a choice of usually three to five options. These portfolios range from conservative to aggressive. This approach has alternative variations and names such as "managed portfolios," "date targeted funds," "life strategy funds," "life style funds" and others. In general, each portfolio offered is a comprehensive mix of many investments with a differing risk/return characteristic. Just how comprehensive the investment mix is can vary greatly. Mutual fund companies generally use their own funds to create these portfolios, while some professional advisors and other investment organizations will combine funds from different families, and still others will use independent money managers to construct these portfolios.

Plan participants can be overwhelmed with the choices available under the Stage 2 or Stage 3 option and may experience apathy or anxiety with respect to the plan's investments. The extent of education and unbiased guidance provided to the participants is often inadequate to make the type of elections that they are required to make under the plan. The Stage 1 approach (if the portfolio is well managed) makes sense only if the plan happens to consist of cloned plan participants–which leaves us with the Stage 4 approach. Individuals know their ages, their anticipated retirement date, how crucial the plan funds are to their retirement security and their willingness/ability to assume risk. This is the information needed to select an appropriate life style portfolio.

This article should not be interpreted to be an all out endorsement of life style portfolios. Clearly there are plan participants who appreciate the large selection of options and are capable of building well–balanced portfolios that reflect their particular circumstances. These individuals however usually are more educated, more successful and less reliant on their defined plan accounts than the majority of plan participants.

In light of the growing importance of defined contribution plans (due to the demise of defined benefit plans) and the sophistication needed to invest in today's complicated global economy, the portfolio approach may serve the vast majority of plan participants better than the other three approaches noted. It is still required and necessary that the plan trustees carefully select investment providers that offer portfolio options which are well diversified and offer distinct risk/reward characteristics. The plan trustees must also make certain that the options made available are both cost– and performance–appropriate and continue to monitor the selections periodically and make changes if needed. Finally, plan participants must be sufficiently educated so as to be able to make a selection that best suit their individual circumstances as well as appreciate that as their circumstances change, so might their portfolio selection require change.


Mark Shemtob is president of Abar Pension Services of Florham Park, New Jersey. He is an associate of the Society of Actuaries, Enrolled Actuary, member of the American Academy of Actuaries, and member of the American Society of Pension Professionals and Actuaries. He teaches at Rutgers University Business School. He can be contacted at shemtob@abarpension.com.