Asset Allocation Models, Target-Date Funds, and Automatic Rebalancing

Make diversifying and rebalancing accounts easier for employees

Historically, employees who didn't have the experience to make informed investment decisions were overwhelmed and intimidated by the prospect of manually diversifying and rebalancing their accounts.

With today’s retirement plans, you can provide your clients with access to asset allocation models, target-date funds, and automatic rebalancing so that their employees can easily manage their savings based on their personal risk preferences and goals.

Asset Allocation Models

Asset allocation models are built with a mix of investments across different asset classes. These models are created with specific investor profiles (e.g., conservative, moderate, aggressive, etc.) in mind to help align with particular objectives and risk tolerance.

When participants choose an asset allocation model that fits their personal savings goals, smart investing becomes quick and easy. Rather than selecting a number of individual investments, they can choose one of several portfolio models based on their age or risk tolerance.

In addition to reducing the number of choices that participants have to make, these models foster a disciplined approach to investing through built-in benefits such as proper diversification and rebalancing. Perhaps most importantly, they can help participants stay invested through extreme changes in the market. At Ascensus, we tracked plan participants who were invested in asset allocation models from the beginning of 2009 and through the end of 2011. In arguably one of the most volatile market periods ever, over 98% of those participants remained invested in asset allocation models.¹

Target-Date Funds
Like asset allocation models, target-date funds allow employees to choose a single, diversified investment option. However, the asset mix is adjusted toward more conservative allocations based on a specified target date.

The ease with which a target-date strategy can be implemented makes it a popular choice in retirement plans. According to Morningstar’s 2013 Target-Date Series Research Paper, target-date funds saw almost $55 billion in net new flows in 2012, bringing their total to nearly $485 billion. In the first quarter of 2013, target-date assets crossed the $500 billion threshold after taking in an additional $23 billion in new assets.²

Automatic Rebalancing
One of the most attractive features of asset allocation models and target-date funds is automatic rebalancing, which mitigates the redistribution of employees’ assets due to an up or down market. This can help make sure that employees’ investment strategies stay appropriate for their current goals, risk tolerance, and circumstances. Target-date funds are rebalanced on a schedule determined by their portfolio managers, while the employer selects the frequency (quarterly, semi-annually, or annually) with which asset allocation models are automatically rebalanced.

Automatic rebalancing may also be offered to employees as a standalone option outside of target-date funds and asset allocation models. This allows them to automatically have their account balances redistributed at a schedule they choose according to their investment elections at the time of rebalancing.

Research has shown that the portfolio rebalancing system is an effective way to help ensure that employees stay on track with their retirement saving strategy. Forbes compared two portfolios each starting with a $10,000 investment beginning in 1985 and ending in 2010. Both portfolios began with a 60/40 mix of stocks and bonds; one was never rebalanced, while the other was rebalanced annually back to its original target. At the end of the 25-year period, the rebalanced portfolio ended with a higher balance ($97,000) than the un-rebalanced portfolio ($89,000).³

Concepts like diversification and rebalancing can be overwhelming for employees participating in your clients’ retirement plans. Providing access to asset allocation models, target-date funds, and automatic rebalancing allows your clients to simplify those concepts so they can help their employees move closer to achieving their retirement goals.

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1 Source: Ascensus data, December 2013.

2 Source: Morningstar Fund Research, "Target-Date Series Research Paper 2013 Survey." June 2013. http://corporate.morningstar.com/us/documents/ResearchPapers/2013TargetDate.pdf.

3 Source: Brown, Janet. Forbes, "Does Portfolio Balancing Work?" November 16, 2011. http://www.forbes.com/sites/investor/2011/11/16/does-portfolio-rebalancing-work/.

Automatic Escalation

Strengthen employee saving habits with regular deferral increases

An earlier blog entry that focused on automatic enrollment discussed how this modern retirement plan feature simplifies the enrollment process for employees. It also noted that automatic enrollment is as effective as it is convenient: Participation rates among Ascensus plans that adopt automatic enrollment are almost 10% higher than those in plans that don’t.¹

Encouraging responsible savings habits can certainly start with automatically signing employees up for a plan. Once enrolled, however, most employees are content to simply leave their default deferral percentage—often between 3% and 4%²—untouched. More is needed to get them to prepare for the future through the use of higher deferral rates.

Today’s retirement plans utilize automatic escalation to boost savings rates among employees instead of relying on manual deferral increases that are unlikely to be elected.

Automatic escalation allows employees to gradually increase their deferral rates over time. The increases needn't be dramatic—upping deferral rates by just 1% each year can have a meaningful impact on retirement savings balances. When deferral rates are raised in tandem with an annual increase in pay, employees are less likely to notice the effect it has on their paychecks.

Support for automatic escalation of deferral rates has been growing. Ted Benna, creator of the first 401(k) retirement savings plan, has stated that he would make it mandatory for every company with such a plan to automatically enroll employees at 3% of pay and automatically increase that number by 1% every year to a maximum of 10%.³

Research conducted by WorldatWork and the American Benefits Institute suggests that Mr. Benna’s recommendations are being heard, as a survey of employer-sponsored retirement plans showed that 97% of companies that offer automatic escalation increase the default by 1% each year.⁴

At the employee level, plan features like automatic escalation can significantly affect how savers view their retirement security. Recently published findings by Putnam Investments revealed that employees using auto escalation were more confident about their retirement than those who didn't use the feature. In addition, households using automatic escalation had higher investable assets and a slightly higher average deferral rate.⁵

Plans that use automatic features are likely to see improvement in helping employees save for retirement. Automatically enrolling employees and gradually increasing their salary deferral rates over time can put them in a better position to achieve retirement readiness.

1 As of February 1, 2012.

2 Source: WorldatWork and the American Benefits Institute, "Trends in 401(k) Plans and Retirement Rewards." March 2013. http://www.americanbenefitscouncil.org/documents2013/abc-waw-surveytrendsin401kplans-2013.pdf.

3 Source: Kujawa, Patty. Workforce, "A ‘Father's' Wisdom: An Interview With Ted Benna." January 20, 2012. http://www.workforce.com/articles/a-father-s-wisdom-an-interview-with-ted-benna.

4 Source: Source: WorldatWork and the American Benefits Institute, "Trends in 401(k) Plans and Retirement Rewards." March 2013. http://www.americanbenefitscouncil.org/documents2013/abc-waw-surveytrendsin401kplans-2013.pdf.

5 Source: Van Harlow, W. Putnam Investments, "Lifetime Income Scores III: Our latest assessment of retirement preparedness in the United States." April 2013. https://www.putnam.com/literature/pdf/DC939.pdf.

Third-Party Benchmarking Services

Present employers with an easier way to measure value for cost

In 2012, the Department of Labor (DOL) issued rules requiring certain retirement plan service providers to clearly and effectively communicate expense information to employers and employees. The goal of this disclosure was to assist plan fiduciaries with understanding the costs for services provided.

The requirement offered financial professionals a unique opportunity to demonstrate their skills and expertise in terms of making it easy for employers to analyze and compare providers.

To take advantage of that opportunity, some have engaged third-party benchmarking services to help employers conduct a thorough review of service providers for their retirement plans. Main areas of focus include recordkeeping services, trust services, and the plan’s investments. In addition to looking closely at expenses, the range and quality of services provided is taken into consideration.

While third-party benchmarking services don’t completely replace traditional evaluation practices, they can offer a more cost-effective and objective way to carry out and document a prudent retirement plan review. In the past, financial professionals had to take on cumbersome reviews alone, usually by soliciting and analyzing requests for proposals (RFPs) from a number of providers. This involved sifting through copious amounts of data to determine if there was good value for cost.

Since RFPs didn't always provide a true “apples-to-apples” comparison of plans, this proved to be an arduous task. The questions were standardized, but the responses varied greatly. In the end, financial professionals and their clients were left to seek additional information elsewhere or make judgment calls without complete certainty.

Today, third-party benchmarking makes it easier to obtain:

• Plan comparisons that show what an employer is getting relative to what is happening in the marketplace in similar plans
• Facts that are broken out to objectively analyze:
• Plan design features
• Employee success measures
• Employer and employee services
• Documentation for fiduciary purposes

The recent emphasis on fee disclosure has made third-party benchmarking services a valuable tool for comparing pricing among providers, as the information provided can go a long way toward helping financial professionals and employers choose the most appropriate services for their plans.

According to independent investment consulting firm NEPC, vendor comparisons in 2011 resulted in savings, on average, of 40% on recordkeeping costs.¹ Furthermore, a study by human resources consulting firm Aon Hewitt found that 52% of defined contribution employers are interested in working with a third-party benchmarking service in 2013 to compare fund, recordkeeping, and trustee expenses. This is up from 35% the previous year.²

In addition to potential cost savings, third-party benchmarking services can help satisfy DOL and ERISA fiduciary requirements, as they demonstrate that a prudent process has been followed for:

• selecting and monitoring plan investment alternatives and plan service providers; and
• ensuring that service provider costs and other plan expenses are reasonable in light of the level and quality of services provided.³

The current regulatory and legal environment has made financial professionals and their clients more accountable for determining the reasonableness of expenses and the suitability of investment offerings. Third-party benchmarking services can assist them in satisfying their fiduciary obligations by providing the data that can help them analyze the elements that will ultimately lead to successful plan operation and high-quality service. 

1Source: NEPC’s Defined Contribution Practice Group’s 2012 Plan & Fee Survey.

2Source: Aon Hewitt, 2013 Hot Topics in Retirement

3Source: http://www.irs.gov/Retirement-Plans/Plan-Participant,-Employee/Retirement-Topics---Fees