Some lifecycle funds used to charge up to 0.75 percent of plan assets to manage asset allocation for employees, but fees have come down significantly as competition has intensified. Now, some companies don’t add a fee for asset allocation at all, and those that do generally charge around 0.5 percent of plan assets for active management. Many lifecycle-fund managers now offer lower-cost alternatives for institutions like 401(k)s, and some are offering low-cost index-based options whose management fees are closer to 0.2 percent of plan assets. When comparing lifecycle funds, plan sponsors should look at the total package of fees — both those for the underlying funds and any additional management fee, says David Wray, president of the Profit Sharing/401(k) Council of America.
Large employers can reduce fees further by creating their own customized lifecycle options based on the funds in their plans, rather than simply offering prepackaged funds from a provider like Fidelity or Vanguard. “If you’ve done your job as a plan sponsor, the fees on the funds in your plan are pretty inexpensive, and they should be good investment options,” says Grant Verhaeghe, investment consultant at Aon Consulting. “You can create a fund that is better than one that simply invests in a proprietary family of funds.”
Anderson says the move to lifecycle funds is the biggest change that Granite City is making to its plan. “[Employees will] get some growth over a long time horizon, and [their investments] won’t be just sitting in a money-market fund earning the bare minimum rate,” says the CFO. Granite City is making lifecycle funds the default option for its plan.
For companies that do offer lifecycle funds, investor education is essential. While some plan participants like to allocate some of their investment dollars to such a fund and spread the rest around, the blended nature of a lifecycle fund may cause the employee to end up overexposed to certain parts of the market. Employers should therefore encourage participants to either put all of their 401(k) dollars into a lifecycle fund or avoid the category entirely, say experts. “They should be an all-or-nothing proposition,” says Verhaeghe.
Some employees also choose multiple lifecycle funds — for example, a 2020 fund, a 2030 fund, and a 2040 fund — in the mistaken belief that doing so is similar to choosing a mix of stock and bond funds and will thus yield better diversification. “That’s a good sign there needs to be some education,” says Verhaeghe. Employers can also structure their plans so that employees may choose only one lifecycle fund.
For more-sophisticated investors who want to make their own fund choices, employers should offer a selection of active and passive funds that span the risk-return spectrum. With a couple of index funds, domestic and international equity funds, a fixed-income option, and a stable-value or capital-preservation fund, employers can cover the critical bases required for diversification.
Yet, while experts have long recommended paring back 401(k) offerings to just 10 or 12 fund choices — and although studies have shown that employees often find a wide array of choices so daunting that they opt to do nothing — the average number of funds offered by companies remains too high at 18, according to the Profit Sharing/401(k) Council. “It’s hard to take things away, and anything you take off the investment menu is viewed as a takeaway by participants,” comments Walton. “Even plan sponsors still have the perception that more is better, even though data shows that having too many options leads to poor participation.”