Morningstar Magazine - June/July 2018 - 71
EXHIBIT 5
The Cost/Benefit of a Better Fit
Average asset-allocation fit improvements of 1 percentage point are
worth cost increases of approximately
one fourth of a basis point;
5 percentage points are worth about
4 basis points; 10 percentage points are
worth about 12.5 basis points.
Average Cost/Benefit (Basis Points)
80
60
In E X H IB IT 5 , average asset-allocation fit
improvements of 1 percentage point are worth cost
increases of approximately one fourth of a
basis point; 5 percentage points are worth about 4
basis points, 10 percentage points are worth about
12.5 basis points, etc. These are economically
meaningful numbers that plan sponsors
should consider when selecting a QDIA for their
plan. Depending on the costs of the different
options, this could certainly influence the selection
of a different target-date glide path or justify the
move to a custom target-date solution. For
example, if one glide path fits a plan's participants
better by 10 percentage points on average, a plan
sponsor should be willing to spend up to
approximately 12 additional basis points for that
better fit.
40
20
0
0
10
20
30
Average Improvement in Asset-Allocation Fit
(Equity %)
Source: Morningstar.
Individual Participant
of
this wouldIndex:
be helping plan
sponsors calibrate
Moderate
Morningstar
Conservative
the pivot point age for a hybrid QDIA with
the highest relative utility. In other words, plan
sponsors can stop guessing and make informed
decisions based on a framework steeped
in theory.
One glaring shortfall to this framework is that
it overlooks the other potential benefits of
retirement managed accounts, which can include
savings-rate advice, retirement-age advice,
tax-location advice, fund-specific monitoring and
recommendations from the plan lineup, annuitization advice, Social Security maximization,
and drawdown (amount and tax efficiency) advice.
Target-risk and target-date solutions don't provide
these, and thus, the analysis focuses on a single
factor-asset-allocation advice. Broader papers,
including
have
Custom ones written by Morningstar,
Equity
Exposure
1
focused on the overall value of financial planning.
100%
They suggest that these other factors offer real
benefits worth paying for, although that discussion
75
is outside of the scope of this paper.
for plan sponsors. Providers have offered more
customized solutions that should improve fit,
typically at higher costs, but plan sponsors were
left without much guidance on cost/benefit
analysis. How much is too much to spend
on customization, or how much customization is
prudent-even necessary-for a plan? This
paper offers techniques for comparing the value
of different QDIA options.
Prudence also requires staying current, and we
believe the QDIA selection landscape has
changed in three important ways. First,
as discussed in this article, greater availability of
participant data calls for a more robust, datadriven QDIA selection process. Second, automated
advice solutions have made managed accounts
not just attainable but in many cases a prudent
alternative to target-date funds. And third,
the rise of the hybrid plan has made managed
accounts attractive to a wider set of plans.
We believe the techniques described here
will empower plan sponsors and their consultants
to stop guessing and use an easy-to-implement,
yet rigorous, QDIA selection process. K
Thomas M. Idzorek, CFA, is chief investment officer,
retirement, with Morningstar Investment Management. He
is a member of the editorial board of Morningstar magazine.
David M. Blanchett, Ph.D., CFA, is head of retirement
research with Morningstar Investment Management. He is
a member of the editorial board of Morningstar magazine.
Daniel Bruns is head of large plan strategy/solutions
with Morningstar.
Fit at a Low Cost
UsingAverage
this framework,
Misfit (%) we looked at a wide range
of potential
disconnects-cases
in which
Conservative
12.2
Moderate
9.6
the investor is invested in 100% equity when he or
Custombe 100% in fixed
5.7 income, cases in
she should
which the investor is invested in 100% fixed income
20
30
when he or she should
be 100% in40equity, and 50
Age
almost everywhere in between. We looked at
10,000 possibilities. This led us to the creation of
E X H I B IT 5 to assist those who might be seeking
a rough heuristic to quantify the advantage
of a better fit.
50
Prudence requires defined-contribution-plan
sponsors to think carefully about fees and
keep costs down, but that doesn't mean selecting25
the cheapest QDIA, especially if the cheapest
0
solution doesn't fit the plan's population
60
70
80
well. Prudence implies finding the right QDIA for
the right price. Fit at a low cost produces the best
value, or utility, for a plan.
Unfortunately, understanding fit and the trade-off
between fit and cost has been a puzzle
1 See Blanchett, D.M. & Kaplan, P.D. 2013. "Alpha, Beta, and Now...Gamma." The Journal of Retirement, Vol. 1, No. 2, pp. 29-45. Also, Envestnet. 2015. "Capital Sigma: The Return on Advice."
Envestnet white paper, and Kinniry, F.M., Jaconetti, C.M., DiJoseph, M.A., Zilbering, Y., et al. 2016. "Putting a Value on Your Value: Quantifying Vanguard Advisor's Alpha."
global.morningstar.com/Morningstarmagazine
71
http://global.morningstar.com/Morningstarmagazine
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