Behavioral psychologists long ago busted the myth that there’s safety in numbers. Are class-action attorneys about to enforce this lesson on unsuspecting 401(k) plan sponsors?

There’s no question, with target-date funds leading the way, qualified default investment alternatives (QDIAs) have become the de facto standard for most 401(k) plan sponsors.

Unfortunately, the comfort of following the crowd often leads to sloppy due diligence. QDIAs, for all their safe-harbor promise, contain just enough potential thorns to leave a lazy plan sponsor all scratched up (see “QDIA Fiduciary Red Flags 401k Plan Sponsors Must Look Out For,” FiduciaryNews.com, June 14, 2016).

For all the talk of employee education, it’s very easy to forget plan sponsors need regular education, too. In fact, if I may be so bold to maintain, before you can educate employees, you must first educate the plan sponsor.

Why? Because the actions of the plan sponsor instruct the employees more than any 60-minute lunch-time class can.

If plan sponsors, by the way they behave, demonstrate to employees that it’s OK to ignore good practices and commit time-honored mistakes, you can have Warren Buffet spill all his secrets before you get past the main course at that lunch meeting and guess what employees will still do? Ignore good practices and commit time-honored mistakes.

In the work-a-day world of 401(k) plans, it’s monkey-see-monkey-do. If the plan sponsor doesn’t take the 401(k) plan seriously, neither will the plan participant.

That’s when the hidden peril of the QDIA becomes most dangerous. Let’s just talk about two of those dangers, one for each of the most popular QDIAs.

By far the most used, the biggest hazard of target-date funds lies within the ease of the very premise of TDFs. It’s just too tempting to reduce all the complexities of a personalized long-term investment strategy to a single variable: age.

Mind you, this sin is not limited to the field of retirement investing or even investing in general. No, the accident of birth has led to a very many wrong-way turns. Just look at the public approval of horoscopes. (As a trained astrophysicist, saying the word “astrology” has the equivalent effect on me as scratching fingernails across the chalkboard has on most people.)

Indeed, harkening back to our previous reference to psychology, there’s a whole sub-world of research on this in the “nature vs. nurture” debate.

But I digress.

Almost all experienced professionals agree picking a generic asset allocation based solely on the date of one’s birth is a folly. Yet, that’s precisely what TDFs do.

Let me ask you this simple question: Does a 50 year-old with a billion-dollar trust fund inherited from his grandfather need to invest his retirement plan the same way a 50 year-old divorcee with not many retirement assets to her name?

Obviously, no. Each has their own specific return requirement – one much higher than the other – meaning there’s no mandate to invest these two very different people in exactly the same way.

As an alternative to TDFs, risk-based funds appear to address this concern. Alas, here’s where the lack of education comes through at all levels, including that of professionals who aren’t as up-to-date on things as they’d like to be.

The issue appears to be the fumbling over the use of the word “risk” (the fact we call them “risk”-based funds only adds to the dilemma). Old-style thinking – which remains pervasive in the industry – equates “risk” with “risk tolerance.” (With “risk tolerance” came the ubiquitous “risk tolerance questionnaire, an artifact of the old brokerage industry suitability model, which thankfully appears on the way out.)

No, when we speak of “risk” here, we need to substitute the phrase “return requirement.” It’s an inexact switch but more in line with the intentions of using risk-based default funds.

A better understand of the foibles of “age” and the fallacy of “risk” begins with training plan sponsors to appreciate the true meaning of these applications (that is, after all, what they are).

Add this to the long list of things to talk about in this new era of retirement plan fiduciary.

Instant Insights /

Plan sponsor lemmings take a bigger chance than they realize with QDIAs

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