The Appropriate Age for Transition to Managed Accounts in a Qualified Default Framework: It Might Be Earlier than You Think

In this article, we review evidence of retirement under-saving and potential solutions, as well as empirical evidence regarding investor reaction to negative market returns. We present new corroborating evidence from fund flows around the recent volatile market events in 2020 that indicates a rising loss aversion, just as asset levels become significant with investors approaching retirement. We surmise that recent trading activity implies an aggregate investor preference for target-date fund (TDF) portfolios within a 20-year time horizon of retirement, with a volatility profile that is potentially too conservative for requisite savings in later years, due to concomitant lower portfolio return potential combined with the aggregate under-saving problem. This mismatch in investor preferences is compounded by a reactionary tactical investor trading strategy that essentially buys high and sells low. We propose that the rising investor loss-aversion problem can be mitigated by including guaranteed retirement income products in the asset mix in a defined contribution qualified default investment alternative setting to provide for the desired downside risk protection against extreme events, or else by shifting investors from a TDF to a managed account (MA) setting in later years to accomplish the same goal, or by utilizing both approaches in tandem. Given the evidence of MA utilization in increasing aggregate savings rates, reducing portfolio risk levels and its potential to meaningfully address the serious measured return drag from investor return-chasing behavior, the potential benefits can outweigh the higher average fee burden for managed advice in many cases. The question then becomes at what age do the benefits outweigh the potential costs, on average. Based upon the recent empirical evidence of TDF flow data from 2020 and data on average account balances, we propose that the appropriate age for automatic transition to managed accounts could be as early as 40.