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Keep an Eagle Eye on Clients’ 401(k) Plans

By Thomas Coyle August 12, 2013

Most financial advisors keep an eye on their clients’ retirement accounts. But the growing popularity of target-date funds in 401(k) portfolios and the specter of rising interest rates make such oversight especially important.

Keeping tabs on the holdings in their clients’ 401(k) plans has to be “part of what advisors are looking at in order to do a good job,” says Sandra Adams, an advisor with the Center for Financial Planning, an independent Raymond James affiliate in Southfield, Mich. At her firm, which manages about $800 million, advisors ask to see clients’ quarterly 401(k) statements to make sure their performance and asset allocations fit in with their overall financial plan.

At a minimum, Adams and her colleagues take this data into account to minimize “broad strokes” overlap between retirement holdings and client portfolios under their purview. And, where appropriate, they make recommendations on retirement accounts, although they’re careful to keep such recommendations at the asset-allocation level to avoid compliance concerns about providing detailed fund- or security-level advice on “held away” retirement accounts.

There’s usually a bright line between advisors who work directly on taxable investments and a growing cadre of advisors who provide investment-consulting services to defined-benefit-plan sponsors and beneficiaries, according to Matt Sommer of Janus Capital Group’s retirement-strategy unit. This separation makes it important for taxable-client advisors to know the contents of their customers’ retirement accounts — and perhaps be ready to take action to keep clients’ retirement plans on track.

This kind of oversight is especially vital now, with more retirement nest eggs in target-date funds and with interest rates edging higher.

Target-date funds are taking off thanks to the Pension Protection Act of 2006. This law lets plan sponsors select them as a kind of default setting for 401(k) enrollees. Since then, legislation green-lighting auto-enrollment in 401(k)s has helped fatten target-date vehicles even more. Casey Quirk, a consulting firm that works with asset managers, estimates that 80% of new cash inflows to 401(k)s and nearly half of the total money in these vehicles will be in target-date funds by 2018.

Meanwhile, with interest rates inching up in anticipation that the Fed’s “quantitative easing” campaign will end soon, the popularity of these funds could have some alarming consequences.

Matt Sommer
“Generally, target-date funds become more conservative over time, which generally means a greater allocation to fixed-income investments,” according to Sommer. Fixed income can lose principal when rates rise. Right now, “a 1% rise in rates will result in a 5.6% decline in the fixed-income portion of a target-date fund” pegged to Barclays Capital Aggregate Bond Index, he says.

This combination of rising rates and bigger fixed-income allocations in target-date funds could be particularly threatening for 401(k) investors who are close to or in retirement.

The point is, target-date funds can help younger clients get a start on saving for retirement, but they “may not offer the customization and personal advice needed by older participants whose 401(k) represents one of their largest assets,” says Sommer.

So what can advisors do to protect older clients from target-date fund erosion? If clients are at least 59½ and the plan sponsor allows it, they could roll over some or all of their 401(k) assets into an individual retirement account under their advisor’s care.

Alternatively, “advisors might consider using a client’s non-401(k) assets to gain exposure to” asset classes not in the 401(k)’s target-date funds, or something like Treasury inflation-protected securities, or TIPS, which are supposed to do well in inflationary periods,” Sommer suggests.

“Other opportunities may include alpha-seeking equity managers” as a counterpoint to passively managed target-date funds, “as well as alternative investments,” he adds.