What to Make of a Managed Account?
If you’ve worked in the employee retirement world for anything over a week or so, you have heard the term “managed account.” For a long time, managed accounts have been the primary topic of discussion for employers who offer retirement plans, such as 401(k) arrangements; they have also become a darling of the retirement provider community, including such powerhouse mutual fund families as Vanguard and Fidelity. Despite their ubiquity, managed accounts remain a mystery to most employees: thus, it’s time for a new and simple definition.
Historically, employee participation in sponsored retirement plans, such as 401(k) and 403(b), hovers around 30 percent. By any reckoning, 30 percent is far lower than it should be. It reflects a disheartening trend: none of us is actively saving for retirement. Most observers argue that the rate of retirement plan participation should be twice what it is. Here’s the dilemma: how to double up on the 30 percent rate?
Historically, retirement income has fallen into one or all of the following categories, the so-called three-legged stool: Social Security, employer-sponsored retirement plans, and personal savings. Rarely are these income sources sufficient on their own. Sadly, most people only have Social Security to rely on. Sadly, too, is the fact that the average Social Security monthly payout averages slightly less than $1,000 a month. This is one of the greatest threats to the safety and security of individuals who unknowingly believe that the government will come to their rescue upon retirement.
It’s a belief that may lead to catastrophe over the next 25-30 years.
Here’s where managed accounts enter the picture. A managed account looks like this: a retirement plan provider, such as Fidelity Investments, creates model portfolios that are tailored to each individual in a retirement plan. These portfolio (mutual fund) options use sophisticated algorithms to determine the best asset mix for Participant A or B or C. They almost always rely on age as the primary factor in portfolio selection. Thus, an individual age 60 may be placed in a portfolio that looks like this:
● 30%--Value Fund
● 30%--Balanced (between stocks and bonds) Fund
● 25%--Bond Fund
● 15%--High Dividend Fund
The individual’s account is “managed” in this way: each quarter, the plan provider will rebalance the allocations based on market performance. Let’s say that after three months of market exposure this individual’s allocation is more like 40, 30 and 15 and 15 percent. Fidelity, in this case, will buy or sell each fund to restore the original allocation. Approximately every five years, the plan provider will modify the algorithm to create a new allocation. The closer one gets to the so-called normal retirement age, 65, the less exposure these allocations will have to stocks, which can go up or down dramatically every day. The same applies, to a lesser degree, to bond funds. The idea is to reduce portfolio volatility as the plan participant ages.
How, you may ask, does a managed account aid plan participation? If it looks on the surface like a managed account is all about portfolio creation, you are right.
But here is how a managed account increases retirement plan participation. The federal government has mandated that managed accounts are an acceptable default investment vehicle for employees. By default, the federal government is saying that the employer, without employee consent, may force a worker into any of these accounts. If an employee has not chosen to participate, the employer may choose accordingly for the participant. It’s true the employee can always “opt out,” but historically few ever do.
Why should an employer use managed accounts? The answer is simple. Employees who are covered by a retirement plan need to save for the future. They can do so on their own, which is the better outcome, or the employer can force them to participate and without permission place them in a government-approved managed account. If this has the whiff of big brother, so be it. Often, we need to be told what to do, at any age.
