The New Mix

Mark Anderson is in the middle of overhauling his company's 401(k) plan. Anderson is the finance chief of Granite City Electric Supply Co., a Quincy, Massachusetts-based distributor with about 180 employees. The project began because he and the company's investment committee wanted better service from Granite City's 401(k) provider. But as they started reviewing the plan, Anderson realized there was another reason to change. "We offer something like 25 or 35 funds," he says. "It's excessive. People get overwhelmed."

Gone are the days when designing a 401(k) plan meant little more than offering every kind of fund under the sun and letting employees choose among them. Today, companies realize that the investment behavior of many 401(k) participants ranges from the discouraging to the downright frightening. Moreover, research has shown that offering a slew of options can actually stymie employee choice and hinder plan participation.

As a result, more and more companies are taking their plans back to the drawing board. The task is becoming increasingly urgent, as the oldest members of the baby-boom generation approach retirement armed mostly with 401(k) savings. Companies like Granite City are redesigning their plans with an eye to providing a more manageable and appropriate menu of investment options. They are striving to make their plans as balanced as possible, adding healthy new choices such as lifecycle funds and collective trusts. And they are monitoring their plans to make sure that funds don't drift from their stated goals.

There is also another reason for CFOs to revisit the mix of fund choices and structure of their 401(k) offerings: the Department of Labor has just released its final ruling on the types of investments deemed appropriate for automatic enrollment. Money-market and other stable-value funds, which many companies offer as a default option for employees, didn't make the cut. The three types that did: lifecycle funds, balanced funds, and professionally managed accounts. (The DoL approved capital-preservation products as qualified default options for only the first 120 days of plan participation.)

Age Appropriate
Given the DoL's blessing, lifecycle funds should become markedly more popular. Also called target-maturity or target-date funds, lifecycle funds first appeared in 1995 but have just begun to catch on in the last five years. Still, just 33 percent of employers currently offer them in their 401(k) plans, according to the Profit Sharing/401(k) Council of America.

Like balanced funds, lifecycle funds comprise a balance of stocks and bonds. Unlike balanced funds, they are managed to automatically shift their investment mix to an appropriate level of risk as the employee ages. Their names — such as "Vanguard Target Retirement 2020 Fund" or "Putnam Retire Ready 2045" — usually feature retirement dates, making it easy for employees to choose the right fund. While some criticize the funds as too conservative or not diversified enough, they should provide better growth over the long term than stable-value vehicles.

"If you are on the hook as the fiduciary, you're thinking, 'Let's get folks into an investment structure that is appropriate for their age and their time horizon,'" says Sue Walton, senior investment consultant at Watson Wyatt Worldwide. "[Lifecycle] funds are appropriate and consistent." Forty-five percent of employees invest in lifecycle funds when they're available, according to data from Hewitt Associates.

Some lifecycle funds used to charge up to 0.75 percent of plan assets to manage asset allocation for employees, but fees have come down significantly as competition has intensified. Now, some companies don't add a fee for asset allocation at all, and those that do generally charge around 0.5 percent of plan assets for active management. Many lifecycle-fund managers now offer lower-cost alternatives for institutions like 401(k)s, and some are offering low-cost index-based options whose management fees are closer to 0.2 percent of plan assets. When comparing lifecycle funds, plan sponsors should look at the total package of fees — both those for the underlying funds and any additional management fee, says David Wray, president of the Profit Sharing/401(k) Council of America.

Large employers can reduce fees further by creating their own customized lifecycle options based on the funds in their plans, rather than simply offering prepackaged funds from a provider like Fidelity or Vanguard. "If you've done your job as a plan sponsor, the fees on the funds in your plan are pretty inexpensive, and they should be good investment options," says Grant Verhaeghe, investment consultant at Aon Consulting. "You can create a fund that is better than one that simply invests in a proprietary family of funds."

Anderson says the move to lifecycle funds is the biggest change that Granite City is making to its plan. "[Employees will] get some growth over a long time horizon, and [their investments] won't be just sitting in a money-market fund earning the bare minimum rate," says the CFO. Granite City is making lifecycle funds the default option for its plan.

For companies that do offer lifecycle funds, investor education is essential. While some plan participants like to allocate some of their investment dollars to such a fund and spread the rest around, the blended nature of a lifecycle fund may cause the employee to end up overexposed to certain parts of the market. Employers should therefore encourage participants to either put all of their 401(k) dollars into a lifecycle fund or avoid the category entirely, say experts. "They should be an all-or-nothing proposition," says Verhaeghe.

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