Do you remember back in grade school when a new kid would join your class at the start of the year? You never knew what to expect.
Hopefully you gave him or her the benefit of the doubt, but let’s face it, that didn’t always happen. You judged. You made assumptions. Maybe you gave the new kid a chance, maybe not. In the end, though, your interactions with that new classmate over a period of time ultimately dictated whether or not you formed a friendship with him or her.
Managed accounts are the new kid.
To be fair, managed accounts in company retirement plans have been around since the early 2000s, so characterizing them as a newcomer is not exactly accurate. But in terms of the latest innovations in the retirement plan industry, managed accounts are certainly one of the more recent developments.
What is a managed account? The common description goes something like this: “A managed account is a professionally managed investment portfolio that is tailored to an investor’s unique personal circumstances.”
Think of it like a made-to-order pizza. Your preferences and tastes build the ideal pizza – or portfolio, in this context.
In other words, if you sign up for a managed account in a company retirement plan (401k, 403b, etc.) an investment professional theoretically collects your personal information – age, assets, liabilities, willingness to take risk, fears, and future plans – and uses it to construct a portfolio uniquely designed for you.
Sounds pretty good, right?
In fact, that very pitch has goosed the popularity of managed accounts in recent years. According to Deloitte, a consulting firm that surveys plan sponsors each year, as of 2015 34% of company retirement plans offered a managed account option, up from 25% in 2010.
Retirement plan recordkeepers have witnessed this growth in managed accounts and now want in on the action. They too are launching competing lines of proprietary managed account services.
Is all the hullabaloo justified? In our opinion, no. At least not based on the managed account services we often evaluate.
In our opinion, there are three big problems with the average managed account service.
Problem One
Providers of managed accounts typically tout the customization of their recommendations to develop personalized portfolios. In practice, this “customization” often amounts to a 10-question risk questionnaire. Based on how the participant answers those 10 questions, the provider simply plugs the individual into a generic portfolio (conservative, moderately conservative, moderate….etc.).
There is no follow-up from an advisor to determine if the risk level from the survey is rational. There is no attempt to incorporate outside assets. There is no effort to project retirement income needs based on the participant’s current situation or desired goals.
Sorry, that’s not customization. That’s boilerplate.
Problem Two
Managed accounts customarily don’t change with you. Sure, the manager of the managed account may tweak the allocation of stocks versus bonds or small cap stocks versus large cap stocks based on his or her outlook on the market. But that outlook has nothing to do with the changes in your life, which is generally a better gauge of when to make portfolio modifications.
As the saying goes, the only thing that stays the same is that everything changes. So it is important to have a portfolio that isn’t static. As participants experience life events and as they grow older, their portfolios should change right along with them.
The managed accounts we have seen do not do this. Typically, if a participant initially selects a managed account that is aggressive in style, the participant remains in that aggressive style until he or she requests a change. It does not happen automatically.
Ideally participants would monitor their accounts over time, but that doesn’t always happen. With the average managed account, a professional isn’t monitoring the portfolio either. That doesn’t make sense to us.
Problem Three
Research shows that investment costs matter. Fees detract from portfolio growth.
To be clear, some fees are justified and are worth every penny. Unfortunately, research confirms that additional money spent on investment management is often not worth the cost. It is difficult to beat the market over time, so trading in and out of investments based on a certain market outlook is usually a recipe for lower returns over longer periods of time.
Managed accounts command an additional fee, frequently 0.25% to 0.50% of the assets in the account. If the managed account could beat the market by more than that amount over time, the fee would be worth it. We doubt that will come to pass for a large majority of managed accounts.
Our prediction is that high-cost managed accounts will not beat similarly positioned low-cost target-date funds over long periods of time.
Our Approach
For our clients, we offer a low-cost target-date fund series, accompanied by an actual financial advisor to assist participants with more complex or unique circumstances. For those we meet with one-on-one, we provide individual advice that is uniquely tailored to their needs. We follow up twice a year and make changes to the portfolio as personal circumstances change.
This type of service requires time and personal attention. A short risk-based questionnaire or a sleek web interface doesn’t cut it.
It takes work to get the information necessary to give good financial advice. That’s where many of today’s managed account services miss the mark. A managed account done right is valuable. A managed account done wrong is not only valueless but likely damaging to participants’ long-term wealth.
We have seen far too many managed accounts that are merely glorified – and more costly! – risk-based funds. Participants in those services are hindered, not helped.
In short, based on our experiences evaluating managed account services over the past few years, we do not see a need for plan sponsors to strike up a friendship with most managed account providers at the current time.
No disrespect to the new kid – he just has some growing up to do.