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Americans who are saving on a 401 (k) plan may have money hidden in a robo-advisor – and they may not even know it.
Robo-advice is basically professional money management that is guided by an algorithm (a robot, so to speak) and largely enables investors to keep their hands free.
Companies that offer retirement plans are increasingly automatically enrolling their employees in 401 (k) plans. Most are redirected to some sort of robo-advisor.
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According to the Plan Sponsor Council of America, about 60% of 401 (k) plans used auto-enrollment in 2019, up from 42% a decade earlier. This helps to overcome the indolence that can prevent a person from saving.
“They’re taking off,” said Keith Gredys, chairman and CEO of The Kidder Company in Clive, Iowa, who works with 401 (k) plans and investors, of auto-enrollment. “[Employees] go in and tend not to come out. “
TDFs and Managed Accounts
About 66% of 401 (k) plans channel these automatic savings into target-date funds, according to the council, a trading group that represents companies that offer retirement plans.
TDFs are perhaps the simplest version of a robo-advisor – they automatically switch savings from aggressive (lots of stocks) to conservative (lots of cash and bonds) depending on an investor’s planned retirement age.
Approximately 5% of 401 (k) plan to have default funds in a “managed account”. For such accounts, algorithms select asset allocation based on factors beyond bare age, such as income, savings rate, employer contributions, and amount of non-401 (k) savings.
Employers must notify employees that they will be automatically enrolled in a 401 (k). But those who aren’t paying close attention may not know that part of their paychecks is being invested in a robo-advisor.
Robo-advisors have become fashionable over the past 15 years to capitalize on investor demand for easy and cheaper investments.
For example, according to the Plan Sponsor Council of America, about 80% of 401 (k) plans offer funds with target dates, up from 64% a decade ago.
“Most people are terrible investors,” said Philip Chao, a certified financial planner and chief investment officer for Experiential Wealth, based in Cabin John, Maryland.
“They are varied [and] professionally managed, “said Chao of target funds and managed accounts.” So you don’t have to seek an advisor; it’s done for you.
“And they’re easy to understand, so they’re becoming very popular.”
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There is also a legal justification for employers to automatically channel funds into such investments – the 2006 Pension Insurance Act provided additional safeguards for this.
However, Chao does not technically see target funds as advisors, as they only tailor asset allocation (the mix of stocks and bonds) to the year in which someone intends to retire.
Managed accounts, on the other hand, are more tailored to the individual as their asset allocation is based on different data points.
However, managed accounts tend to be more expensive too – and that can be a problem for investors who are auto-enrolled, according to Chao.
Managed accounts often rely on investors to enter certain data points (ex[k] Savings) to manage their investment mix. However, it is unlikely that these inputs would be made without investor involvement, as it is more likely after automatic registration – which may negate the additional cost.
“You shouldn’t skip your money blindly,” said Chao. “You should know the cost.
“And you should make sure the employer has done their expense control job.”