Allow Investors to Own Their Retirement

Allow Investors to Own Their Retirement
by Max J. Rudolph

While life style funds make sense for some, a growing minority of individuals successfully make their own investment decisions. Their needs should not be ignored.

Mark Shemtob has written a very interesting article that details how the 401(k) market got to its current state, and suggests that most participants would be better off using life style funds. As some editors of The Actuary reviewed the article, it seemed like there was another side of the story that could be expanded on. As an individual investor who does not practice in the pension area, I volunteered.

While there are many studies stating that the average investor would be better off outsourcing his or her investment decisions, these results are always presented as point estimates. The contention in this article is that many plan participants are currently qualified to make their own investment decisions and that this number would steadily increase if transparency, education and choices all increased.

Fiduciary duty has multiple definitions. Should trustees for a company–sponsored retirement plan define this obligation based on the least informed investor? This is how most plans operate today. Does the fiduciary responsibility apply to each individual in the plan? Is the time line long–term or short–term? This complementary article will take the view that individuals should be provided the tools to optimize their assets many years in the future.

At one time, the standard for retirement savings was described using a three–legged stool. These legs were defined as employer sponsored plans, government run social insurance and private savings. Each needed to pull its own weight for individuals to have a happy retirement. These asset groups are each under varying degrees of pressure. Employer sponsored defined benefit plans are generally being replaced by defined contribution plans, usually a 401(k) plan in the United States. These plans place the investment risk (and potential return) with the employee. In the United States, Social Security is under demographic and fiscal pressure, while personal savings levels are at record lows. Individuals need to take ownership of their retirement, considering each and every one of their assets. Simplified asset allocation schemes used in 401(k) plans may provide false security to a participant. Here's why.

Asset Allocation
To maximize the value of asset allocation, all of a family's assets should be included. Details behind tax qualified and non–qualified plans of both spouses should be aggregated. This can be hard to do, as most publicly traded mutual funds report their positions only quarterly and could drastically change their invested positions between reporting dates. Funds managed privately, especially hedge funds, are even less transparent to the participant. Defined benefit plans and Social Security payments, which as fixed cash flows in the future act as proxies for bonds, are also an asset and their discounted value should be included.

When a life style fund is placed in a single account, it does not consider the asset mix that is in other accounts. This might include company stock, cash, property, payout annuities and alternative asset classes. Transparency of the funds offered within a 401(k) plan would help investors to perform holistic asset allocation.

Fiduciary Duty
Fiduciaries of employer–sponsored retirement plans have a duty to all participants. Yet they often focus on the least sophisticated investors. When a credit union is set up for employees, the directors are elected by the member employees. Why does it make sense for pension fund trustees to be chosen differently? It is confusing to the senior executives chosen which fiduciary duty they are serving at any one time. This makes them more susceptible to choosing plans with high expenses that return a fee to the company. These trustees often outsource the specific fund choices. While employees might be told this is to bring the expertise of these third parties to bear, its primary reason is often to shift accountability to others. The hired firm often chooses a middle of the road fund, focusing on a short time horizon, rather than one that will outperform a benchmark over time. Ten years ago this led to the recommendation of growth funds with high percentages of technology companies at historically high levels relative to industry standards. Contrarian funds generally outperform over long time horizons, but those funds were not chosen as performance was chased.

Life style funds are marketed as if they are index funds. They should invest consistently, choosing index funds with low expense loads.

Investor Education
The public is fully capable of understanding many investing tools. The point is often made that many investors have made poor investment choices in the past, but most of the time they are following advice of the so called experts. Not everyone wants or needs the self directed option. However, if proper education is provided the informed investor population will grow along with the personal circle of competence around their investment decisions. There is an analogy with grocery stores. Prior to the end of World War II, grocery stores did not offer a lot of variety. Today there are entire aisles offering cereal and milk. No one complains, and the consumer is accountable for choosing from the range of sugar coated cereal and high fat milk to healthy cereal and low fat milk. Consumers have been provided the tools to be educated over time about the dietary value of each choice and are allowed to choose.

Consumers planning for their own future needs should be encouraged to follow the same path. It will take time, and life style funds can help educate through transparency. Providing information like expense loads and portfolio composition of each fund at least monthly (with timely reporting) will go a long way toward a more educated public. Balancing risks and returns is something consumers already do, from nutrition to banking. An opportunity exists for actuaries in this area. For example, by expanding tools developed to value variable annuities during the recent C-3 Phase II project, actuaries can apply stochastic scenarios to individual asset portfolios to help individuals understand the risk–return relationship of their specific asset mix. Actuaries can leverage previous work to provide a jump start to the emerging Personal Actuary practice area.

There is a movement toward consumer accountability for funding their family's retirement. The more a company considers itself a long–term trustee for both novice and sophisticated investors, the more knowledgeable their employees will become about their investment choices in all their accounts. Current plans often provide a false sense of security, assuming that plan trustees are acting in a participant's best interests.

Life style funds can lead the way toward increased transparency by using low expense index funds that are publicly traded.

Actuaries should use their knowledge to help individuals traverse this path successfully with transparency and education. By helping individuals take ownership of their own retirement planning, actuaries can make a difference.

Max J. Rudolph, FSA, CFA, MAAA, leads Rudolph Financial Consulting, providing services that leverage existing risk management tools to increase firm value. He can be reached at

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