In last week's blog, I proposed giving all employees (public and private) access to the Thrift Savings Plan, which is the low cost, superbly run, 401(k) plan now limited to government employees, including members of Congress. While this would be a very simple fix, it is unlikely to happen. The securities lobby is extremely powerful. Congress is totally dysfunctional. This combination is the perfect storm for inaction.
Here's another suggestion. It could be immediately implemented by employers. No laws would have to be changed. It would fit within the existing 401(k) structure. It's easy to explain: Offer employees a discretionary managed account geared to the targeted income participants will need when they retire. Here's how it would work.
Employees who select this option would fill out an online questionnaire to determine the desired income level they will need in retirement (adjusted for inflation) in order to permit them to maintain their standard of living. They would also determine the lowest level of income needed to cover their basic expenses. The advisory firm and fund manager would have the responsibility for managing the participants' savings to control risks and maximize the likelihood they will achieve their income goals. The investment portfolio would be reviewed monthly, and adjusted, as required. At retirement, the participant would be provided with options to lock in a reliable, inflation adjusted, income stream.
The devil is in the details. The success of this option depends on the advisor and fund manager responsible for investing the funds. An early entrant offering this option is Dimensional Fund Advisors. It's Managed DC Solution was created by Robert C. Merton, a Professor of Finance at MIT and a recipient of the Alfred Nobel Memorial Prize in Economic Sciences in 1997. You can view a video of Professor Merton explaining the basis for Dimensional's Managed DC Solution here.
In order to maximize the probability of achieving the minimum investment requirement, Dimensional invests a portion of available funds in a low-risk, hedged portfolio of fixed income securities. The remaining assets will be invested in a globally diversified portfolio of low management fee, index or passively managed funds, designed to maximize the possibility of reaching the higher income target. Dimensional considers not only the funds currently in the 401(k) plan, but also Social Security Income, Defined Benefit contributions, if any, and future contributions to the 401(k) plan, using a patented, science-based algorithm to dynamically manage interest rate, market, and inflation risks, and to reflect changes in assets, market conditions, and personal circumstances.
The benefit of this option is that it provides 401(k) participants with goals and investment management typically associated with defined benefit plans (remember them?), where the employer managed a pooled fund intended to provide an income stream in retirement. It also transfers responsibility for achieving retirement goals to the advisor and fund manager, with the sophisticated technology, expertise and resources to manage plan assets in a way that vastly improves the likelihood of achieving retirement goals. The current 401(k) system places this burden on employees, many of whom are ill-equipped to make these decisions.
Hopefully, other large index based providers (like Barclays, State Street and Vanguard) will offer similar options. [Full disclosure: I am affiliated with Index Funds Advisors which offers Dimensional Funds, including the Managed DC Solution, to its clients].
Dan Solin is a senior vice president of Index Funds Advisors. He is the New York Times bestselling author of The Smartest Investment Book You'll Ever Read, The Smartest 401(k) Book You'll Ever Read, The Smartest Retirement Book You'll Ever Read, and The Smartest Portfolio You'll Ever Own. His new book is The Smartest Money Book You'll Ever Read. The views set forth in this blog are the opinions of the author alone and may not represent the views of any firm or entity with whom he is affiliated. The data, information, and content on this blog are for information, education, and non-commercial purposes only. Returns from index funds do not represent the performance of any investment advisory firm. The information on this blog does not involve the rendering of personalized investment advice and is limited to the dissemination of opinions on investing. No reader should construe these opinions as an offer of advisory services. Readers who require investment advice should retain the services of a competent investment professional. The information on this blog is not an offer to buy or sell, or a solicitation of any offer to buy or sell any securities or class of securities mentioned herein. Furthermore, the information on this blog should not be construed as an offer of advisory services. Please note that the author does not recommend specific securities nor is he responsible for comments made by persons posting on this blog.