There’s a reason why 401(k) plans took off in popularity in the 1980s.
Sure, you could say it was because of the increased tax benefits for both employees and employers. And, yes, you can also point to how they enabled people to save for retirement at a faster rate than they could in IRAs. Plus, there was free money in the company match! Nope.
All those reasons might be good, but they don’t explain the sudden jolt in popularity of what would normally be considered just another employee benefit.
Many readers might be too young to remember, but the 1980s began an extended era of the reign of the individual investor. With the rise of the stock market, everyone and his brother wanted to get in on the action. And, with 401(k) plans, everyone and his brother (as well as his sister) did get into the market.
Forty years ago, traditional profit-sharing plans had a problem when it came to long-term investing. For those baby boomers just starting off on their careers, these retirement plans were invested too conservatively for their tastes.
They wanted to be more aggressive, and 401(k) options increasingly gave them that opportunity, especially when the Modern Portfolio Theory-Style Box approach took over the industry in the 1990s. The investment industry focused on creating and selling more and more asset classes to fill the ever expanding style box.
Retirement savers were convinced this was in their best interest, and for ten years or so, they rode the bull market of investment invincibility.
But the market always gets the last laugh. The “Lost Decade” immediately following Y2K stunned retirement savers. They were forced to accept they were more lucky than good when it came to picking investments. Many retreated to the comfort of simply not opening their 401(k) statements.
When the dust settled, employees saw a new option in their plans, the target-date fund. This was the “One Portfolio” solution that marked the return of the traditional profit sharing plan age-based investment option. Of course, this came with a twist on that old-fashioned idea. Instead of all workers being placed in a common pool managed to the weighted average age, today groups of workers can choose the specific investment pool based on their actual age.
Alas, with the return of age-based funds comes the return of some of the same problems we saw in the original version (see “401k Plan Sponsors Need to Know the Good, the Bad, and Why TDFs are So Popular,” FiduciaryNews.com, March 14, 2017).
The fundamental flaw with TDFs – the same fundamental flaw of all mutual funds – creates a hole large enough for the reemergence of the MPT-Style Box.
The attraction of the “One Portfolio” solution (e.g., TDFs) is that it allows retirement savers to ignore investment decisions – something they can’t control and which they are generate less expert in – and concentrate more on saving – something they can control and have immediate practical knowledge on.
This focus allows employees to maximize their retirement saving, which is in their best interest.
Unfortunately, TDFs aren’t the perfect investment for anyone (like I said, no mutual fund is).
Like those profit-sharing plans of old, TDFs, despite the promise of age-based specificity, are either too conservative or too aggressive.
To remedy this, there’s a quite logical conclusion to address the best interest of the retirement saver and tweak the overall asset allocation of their portfolio by adding asset specific funds to the standard TDF holding.
If this sounds like the MPT-Style Box’s nose peeking under the tent, consider yourself forewarned.