The need for portfolio optimization at the defined contribution (DC) plan participant-level beyond the allocation of standard target-date funds is a topic that I have been encountering more frequently in recent interactions with industry sources. I had the opportunity to discuss this topic and other high-level trends with David Blanchett, Head of Retirement Research and DC Solutions at QMA, PGIM’s Quantitative Equities and Multi-Asset Division. You’re probably familiar with Blanchett’s years of work at Morningstar, where she published numerous articles and studies on retirement planning topics.
RPA Edge: Let’s discuss this idea of a long-term secular shift towards the distribution of retirement income. what do you mean by that?
David Blanchett: Everyone is going to interpret it a little differently. The change that PGIM DC Solutions sees is the role of employer-sponsored defined contribution plans, such as 401(k), or 403(b), to help individuals achieve better retirement outcomes. I think that historically observed individuals have defined contribution plans like 401(k)s as a way for someone to retire. You work for 30 or 40 years, you retire, and you kick me out of the plan. I think going forward, there is certainly an increasing interest among both employers and participants to keep money in the plan and use the plan as a way to create lifetime income during retirement.
RPA Edge: Is this effort to help employees with retirement income gain momentum?
David Blanchett: It definitely is. If you look at the surveys, there has been a significant trend among plan sponsors/employers and participants to help people figure this out in retirement. I acknowledge that there will always be some plan sponsor who is uninterested in providing participants or employees with a way to work for retirement, but they are becoming the minority, not the majority. More and more plan sponsors are saying that there is a huge potential benefit here. have economies of scale; Institutional pricing. There are things we can do that don’t take too long that can have a significant, positive impact on the results of current and past employees.
I think financial planners can add a lot of value, but the problem is that there’s a huge spectrum of what can happen when you exit a 401(k) plan. If you’re in a larger plan that’s run by an institutional fiduciary, you can get over these constraints on how bad or how good things can get. But when you move to an IRA, anything is possible. What’s interesting and exciting to me is the idea of doing this more inside 401(k) plans, where you can get access to really good investments, really good advice, a lot of things at a relatively low cost that the average American does. Says no, $1,000,000 saved for retirement cannot be found in an IRA.
RPA Edge: How has this change been strengthened by the Safeguarding Act?
David Blanchett: There is increasing interest in including guaranteed income in defined contribution plans to simplify the income process. Defined benefit plans are great for employees but they are not so good for employers. Think about how easy it is to figure out your strategy if you are an employee, when we are talking about you you have income for a lifetime and it is guaranteed. I completely understand why employers have moved away from those offerings, but I think there is still a desire for individuals to replicate that kind of simplicity. You can obviously make income from a portfolio, but that income is not guaranteed to last a lifetime. I think one way that employers can provide that is through offering guaranteed income, so they’re going to offer an annuity, for example, as a distribution option as part of a 401(k).
RPA Edge: You mentioned the need for innovative thinking and flexible solutions with retirement income. What do you think this new thinking could be?
David Blanchett: If I go back about 20 years I used to be a financial planner and I still get people asking me random advice all the time. If you’re 25, I can confidently say save in your 401(k), use target date funds, start saving to buy a house, all that stuff. The problem is that as one gets bigger, so does the complexity of the optimum. If you’re 45, target date funds may make sense. But if you’re 60 or 65, given your overall circumstances and circumstances, a target date fund could pose a very wrong level of risk to you.
This is privatization. It’s not like someone younger has simpler finances, but they have a lot of levers they can pull when things go wrong. If you mis-allocate your portfolio, you may save more, you may work longer, you may spend less. But as you get closer to retirement and move on, those levers may disappear or they reduce in size, so you want to be certain that what you’re doing is the right path for you, which is Makes you an investor or a unique home. One of the implications of flexibility is that target date funds are not always the right strategy for one and they just need a good portfolio to get the best results. And so, it’s really focused on personalization, advice, and guidance, making sure everyone gets the strategy that’s really optimal for them, and not just this “average” investor, who is the target date fund. Usually built around
We (PGIM) have about $6 billion in target date fund assets. I love target date funds–they’re massively improving on self-directed. Anyone who doesn’t like target date funds doesn’t really understand how terrible people are as investors and what they were doing before target date funds were so commonly used. They have really helped people to get better results. But I think almost every company that has really thought about this at some stage is starting to recognize that people need more than just a target date fund.
You know, between asset managers, recordkeepers, everyone in the industry who understands what it really means to create better results, what it will require, we’re going to start creating a variety of solutions and strategies. There isn’t just one optimal investment portfolio for all retirees. People will see it from different angles and for different reasons and that’s what’s exciting. I think the only common theme I see in all these different solutions is the need for personalization. I think what’s exciting about what we’ll see in the next three to five years or five to 10 years is who gets the strategies among the planning sponsors in the DC space.
RPA Edge: Any additional thoughts you can share on that?
David Blanchett: The one word I keep coming back to is personalization and if you think about it, that’s what financial planners have always been doing. To be fair, I wish every single participant in the DC plan could spend hours each year with a certified financial planner but that’s not going to happen – there’s no way that works in terms of economies of scale. We don’t have enough planners to do that. And so, I think we have to find ways to get people better results that are realistic and cost-effective.
A big question like this is how do you recommend people scale? I think it involves a robo-type solution where perhaps the primary interface is online or maybe there is a call center. I’m not sure what that looks like but I’m a big believer in the value of advice and I’m a big believer in personalization and then you have to find a way to make it work so that it’s cost effective and provides better results .