What You Need to Know
- For a participant to want to stay in a DC plan, the plan itself must be retirement ready.
- Core menus need to adapt to meet the needs of both younger and older investors.
- They also tend to lack several important asset classes.
There is an increasing emphasis among plan sponsors on keeping participants in the defined contribution (DC) plan post-retirement. The potential benefits associated with staying in-plan are many, such as fiduciary oversight and economies of scale, including access to institutionally priced investments, which can make the decision a smart one for participants.
However, for a participant to want to stay in a DC plan (versus roll out), the plan itself must be “retirement ready.” A retirement ready DC plan needs to have a variety of features, one of which is access to a robust set of funds that enable participants who choose to do so to build diversified portfolios from the core menu.
The role of the core menu in DC plans continues to evolve, especially given the notable growth in default investments, in particular target date funds, over the last decade.
In recent research, I explore data from 11,643 401(k) plans to better understand where asset class coverage gaps exist across core menus and quantify the portfolio implications associated with the gaps. Two shortfalls are noted.
- Core menus would benefit from a “rebalance” to better accommodate the participants who are most likely to use them.
Younger participants are much more likely to use default investments (e.g. target date funds) while older participants, who tend to invest more conservatively, are much more likely to use the core menu.
This is in direct contrast with common core menu design, where there are typically significantly more equity funds than fixed income funds (roughly three to one). The relatively high proportion of equity funds makes it not only difficult to build efficient conservative portfolios, but it may also lead to excess risk taking among participants (i.e., if the participant follows a naïve allocation strategy or chases returns).
2) Core menus are largely missing important asset classes required to build efficient retirement-focused portfolios.
Efficient retirement portfolios can look very different than efficient accumulation portfolios given the more focused objective of generating an income stream.