The Retirement Plan Advisor’s Guide to Offering Model Portfolio Services

It’s not surprising that individuals who work with a financial advisor feel more confident about the security of their financial future. In fact, according to Northwestern Mutual, most Americans with an advisor believe they’ll work beyond retirement age only if they choose to. This optimism is far less evident among those who don’t work with an advisor, with 6 out of 10 indicating they expect to work past retirement age out of necessity.

Many investors’ worries can be traced back to a single predominant concern surrounding investment selection. For advisors who work with employer-sponsored retirement plans, providing model portfolio services is a great way to help calm these concerns. With this solution, retirement plan advisors can provide plan participants with an efficient way to access a diversified investment mix designed for their risk profile.

What research tells us. The “Legg Mason Global Investment Survey 2018” found that 86 percent of U.S. investors are focused on achieving long-term investment goals, such as saving for retirement or leaving an inheritance. Only 32 percent of those same respondents, however, feel “very confident” that the returns of their selected investments will be sufficient to support a comfortable life in retirement. This apprehension is particularly prevalent among baby boomers, with only 17 percent asserting their confidence. While millennials exhibit notably higher confidence levels, 60 percent of them also admit to allowing emotions to influence their decisions to sell in their 401(k) plan.

In its 2018 study, “Risk-Taking Across Generations,” Vanguard reported that millennials are increasingly exhibiting signs of risk aversion, with the percentage of millennial investors holding zero-equity portfolios rising to 19 percent, up from 13 percent in 2012. While this trend can be explained largely as a response to market conditions and general trepidation remaining in the wake of the 2008 global financial crisis, if left unaddressed, these investors may be faced with an insurmountable gap between what they have saved and the balance required to sustain them through retirement.

Managing risk. Understandably, the discomfort caused by watching an account balance dwindle in the face of market volatility can be difficult to tolerate. One could argue, however, that if investors are unable to withstand the losses that their investments may incur during a period of tumultuous market activity, they have assumed too much risk. By structuring models using various risk and return characteristics, advisors can provide significant value to retirement plan participants on both ends of the spectrum. Those concerned that their investment returns could fall short of their retirement income needs may benefit from adopting a growth model, which would deliver additional return potential while still providing diversification benefits.

In addition, model portfolios may improve the prospects of younger investors who admit to fearfully selling when the market drops. Although a market decline would still have a material impact on their portfolios, their savings would be spread across a greater number of asset categories meticulously selected by their trusted advisor.

Conversely, seasoned investors looking to reduce their exposure to the stock market as their retirement age approaches could employ a conservative model to protect their assets. As Tina Wilson, the head of MassMutual’s Investment Solutions Innovation group, explains, “How retirement savers allocate their assets can make a big difference in both the timing and quality of their retirement. So, it’s crucial for them to know and maintain the right mix of investments, especially as they move closer to retirement.”

As plan participants journey along their retirement path, model portfolios allow them to effectively adjust their holdings to reflect the risk tolerances of their current life stage. As opposed to blindly selling out of equities and into bonds as they age, investors can look to these curated models for risk-based investment guidance.

While it’s certainly possible to build a customized model portfolio for each individual client, that approach requires a substantial time commitment, and there is little scalability or efficiency to be gained for your firm. The option many professional money managers choose is to build standardized allocations that are suitable for most client investment needs. You can use many of the same investment products across different models in varying percentages and perform ongoing due diligence on fewer products that complement one another.

Pay close attention to each fund’s investment history, and consider ticket charges, expense ratios, and fund minimums. Then, be sure to back-test your models to review how they’ve performed historically. A simple way to do this is to build your model portfolios in Morningstar^® Advisor Workstation^SM.

Model portfolios are often considered alongside target-date funds (TDFs). TDFs work to mitigate risk by strategically adjusting asset allocations away from riskier investments to more conservative options as they approach their scheduled retirement date. The hands-off approach they offer can be appealing to investors who have a difficult time with financial decision-making. Model portfolios, however, provide participants with an investment mix outside of the typical TDF. Given the growing prevalence of TDFs, it’s easy to assume that they are adequately paving the road between investors and their retirement goals. In their attempt to appeal to the general public, however, standard TDFs tend to adhere to their predetermined glide paths without giving ample consideration to current market conditions.

Model portfolios allow investors who favor a hands-off investing experience to factor their risk tolerance levels into their investment decisions. For example, an older individual who has multiple sources of income and considerable outside investments may have the ability to bear greater risk than an age-based TDF would allow for. By focusing on risk tolerance as opposed to age, model portfolios cater to the needs of a more diverse range of participants.

While driving superior participant outcomes is undoubtedly the underlying goal for most retirement plan advisors, it is still important to consider the ways in which model portfolios can contribute to the development and growth of a retirement plan practice. In today’s competitive landscape, it is crucial that advisors discover ways to differentiate themselves from their peers. Instead of simply offering oversight around a plan’s fund menu, advisors can better demonstrate their worth to a plan and its participants through the use of model portfolios. And providing education to plan participants surrounding their models can serve as a segue into a wider discussion on their potential financial needs—for wealth managers, this could increase the possibility of attracting these participants as clients. By and large, offering model portfolio services for defined contribution plans can lead to significant benefits for all parties involved.

Could the retirement plan participants you work with benefit from a portfolio based on their risk tolerance? How could offering model portfolios services boost your firm’s value proposition? Please share your thoughts with us below.