The need for portfolio customization at the defined contribution (DC) plan participant-level beyond the standard target-date fund’s allocation is a theme that I’ve been encountering more frequently lately in conversations 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, the quantitative equity and multi-asset division of PGIM. You’re probably familiar with Blanchett’s work from his years at Morningstar, where he published numerous articles and studies on retirement planning topics.
RPA Edge: Let’s discuss this idea of a long-term secular shift towards the delivery of retirement income. What do you mean by that?
David Blanchett: Everyone’s going to interpret that a bit differently. What PGIM DC Solutions sees changing is the role of employer-sponsored defined contribution plans, say a 401(k), or a 403(b), in helping individuals achieve better retirement outcomes. I think that historically individuals viewed defined contribution plans like 401(k)s as a way to get someone to retirement. You work for 30 or 40 years, you retire, and you roll me out of the plan. I think that moving forward, there’s definitely a rising interest both among employers and among participants to keep the money in the plan and use the plan as a way to create lifetime income throughout retirement.
RPA Edge: Is this attempt to help employees with retirement income gaining momentum?
David Blanchett: It definitely is. If you look at surveys, there’s been a significant trend among plan sponsors/employers and participants in terms of interest in helping people figure this out in retirement. I acknowledge that there are always going to be some plan sponsors that have no interest in providing participants or employees with a way to make it work for retirement, but they’re becoming the minority, not the majority. More and more plan sponsors are saying there’s a huge potential benefit here. There are economies of scale; there’s institutional pricing. There are things that we can do that don’t take a lot of time that could have a significant, positive impact on the outcomes for current and past employees.
I think that financial planners can add tons of value, but the problem is there’s a huge spectrum of what can happen when you exit a 401(k) plan. If you’re in a large plan that’s run by an institutional fiduciary, you kind of get these guardrails in terms of how bad or how good things can get. But when you go into an IRA, anything is possible. What is intriguing and exciting to me is the idea of doing more of this inside 401(k) plans, where you can get access to really good investments, really good advice, lots of things at a relatively low price that the average American who doesn’t have say, a $1,000,000 saved for retirement, might not get at in an IRA.
RPA Edge: How has this shift been reinforced by SECURE Act legislation?
David Blanchett: There’s a rising interest for including guaranteed income in defined contribution plans to simplify the income process. Defined benefit plans are great for employees but they’re not so great for employers. Think about how easy it is, if you’re an employee, to figure out your strategy, when we’re talking about you have income for life and it’s guaranteed. I totally understand why employers have moved away from offering those, but I think that there’s still this desire to replicate that kind of simplicity for individuals. You can obviously create income from a portfolio, but that income is not guaranteed to last a lifetime. I think that one way that employers can provide that is via offering guaranteed income, so they’re going to offer annuities for example, as a distribution option as part of the 401(k).
RPA Edge: You’ve mentioned the need for new thinking and flexible solutions with retirement income. What are you thinking of in terms of what this new thinking might be?
David Blanchett: I used to be a financial planner if I go back about 20 years and I still get people asking me for random advice all the time. If you’re 25 years old, I can confidently say things like save in your 401(k), use the target date fund, start saving to buy a house, all these things. The problem is that the complexity of what is optimal really increases as someone gets older. If you’re 45, the target date fund might make sense. But if you’re 60 or 65, well, a target date fund could have a very wrong level of risk for you given your entire circumstances and situations.
It’s personalization. It’s just not that someone that’s younger has simpler finances, but they have a lot more levers they can pull if things go wrong. If you misallocate your portfolio, maybe you can save more, you can work longer, you can spend less. But as you approach and move through retirement, those levers disappear or they decrease in size, so you want to be certain that what you’re doing is the right path for you, given everything that makes you as an investor or a household unique. One thing flexibility means is that the right strategy for someone isn’t always going to be a target date fund and that they need more than just a good portfolio to achieve a better outcome. And so, it really is focused on personalization, advice and guidance, making sure that each person gets the strategy that’s truly optimal for them, not for this “average” investor, which is what a target date fund is usually built around.
We (PGIM) have about $6 billion in target date fund assets. I like target date funds–they’ve been a massive improvement over self-directed. Anyone who doesn’t like target date funds doesn’t truly grasp how terrible people are as investors and what they were doing before target date funds became so commonly used. They’ve really helped people achieve better outcomes. But I think that almost every company that has really thought about this at any level is starting to acknowledge that people need more than just a target date fund.
You know, among asset managers, recordkeepers, everyone in the industry that understands what it truly means to create better outcomes, what it would require, we’re going to start creating different types of solutions and strategies. There’s not just one optimal investment portfolio for all retirees. People will come at it from different angles and for different reasons and that’s what’s exciting. I think the only kind of common theme that I see across all these different solutions out there is this need for personalization. I think what’s exciting about what we’ll see happen over the next, say, three to five years or five to 10 years, is which strategies gain traction among plan sponsors in the DC space.
RPA Edge: Any additional thoughts you could share on that?
David Blanchett: The one word that I come back to is personalization and if you think about it, this is what financial planners have been doing forever. To be fair, I wish every single participant in a DC plan could spend hours every year with a certified financial planner but that’s not going to happen–there’s no way that would work in terms of economies of scale. We don’t have enough planners to do that. And so, I think we’ve got to find ways to get people to a better outcome that are realistic and cost-effective.
There is this kind of great question of how do you give people advice to scale? I think that does involve a robo-type solution where maybe the primary interface is online or maybe there’s 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 outcomes.