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Has the 401k Fiduciary Unknowingly Put Employees in Peril?

June 10
00:03 2014

It doesn’t take a rocket scientist to see the inappropriateness of using volatility to define risk. But it’s become so ingrained in our investment management culture it’ll be almost impossible to purge it. So, instead of simply redefining  the tarnished word SONY DSC“risk,” will replace it with word “peril.” Moreover, we’ll also change our perspective from viewing risk in terms of investment returns to viewing peril in terms of the consequences of an investor missing his goal. Removed from the formula, the spectrum of investment returns then becomes an independent tool to help investors see their relative peril.

Let’s emphasize something important here. During the MPT era, risk became part of the portfolio management formula. In the name of efficiency and elegance, advisers were taught to emphasize risk before constructing the investor’s portfolio. Sure there were other factors, including the return requirement, but for some reason risk floated to the top as the most important of all components. Think about this. By incorporating risk as a factor, we’re using as one of the variables a component of the outcome. This is what Excel would call a circular argument. It’s not an example of an iterative formula, it’s a form of a logical fallacy.

Step one in establishing the new paradigm was removing “risk” as a component of the process. This is what forward thinking advisers have initiated. It’s possible 401k fiduciaries who have failed to fully update their plans to this new paradigm may be looking at increasing their own personal risk in terms of their fiduciary liability. What is this new paradigm and how does it differ from the old? Although we can’t say it has a generally agreed upon name, FiduciaryNews scanned the country and spoke to plan advisers from coast to coast (and in America’s heartland, too) to have practitioners describe this new paradigm in their own terms.

Rather than focusing on risk, most feel it’s better to focus on the investor’s return requirement i.e., the specific return requirements needed to attain specific goals. Because we want a broadly defined model that encompasses goals beyond just investment returns, we’ll call this return requirement the “Goal-Oriented Target” – or “GOT” for short),. “If investors can’t identify their goal, then the 401k statement that comes in the mail is just a series of numbers and meaningless data. What you can do with those numbers, or plan to do, can help an investor achieve long-term success,” says Kevin Conard, Co-Founder of in Overland Park, Kansas.

For some, using the GOT method is critical because, when it’s all said and done, it’s all about achieving goals. Even if we can’t get away from the word “risk,” Andrew Carrillo, President and CEO of Barnett Capital Advisors in Miami, Florida says, “It’s better to speak of risk in terms of failing to meet the goal oriented target because that’s what counts!”

Jeremy C. Brenn, Vice President at Sensenig Capital Advisors, Inc. in Philadelphia, Pennsylvania, also thinks it’s important to move any mention of “risk” towards talking about the downside of failing to meet a specific GOT. He says, “It helps to discuss risk in this fashion because it educates regular investors on the things they should be focusing on versus what they have no control over. Our view is that we can’t control markets, the returns they provide, or the subsequent volatility.”

In the case of Matthew B. Boersen, Partner at Straight Path Wealth Management in Grand Rapids, Michigan, he first shows clients “the ‘risk’ of not reaching the investment return goals and what that means for retirement projections.” He says, “This simple step is useful for investors who want to shy away from equity and more towards low yielding fixed income for safety, despite having two or more decades before retirement. After a market drop, we still show the modeling but for a different reason. We show it to illustrate the minimal impact a 10% or 20% drop has on 20-30 year plans. A temporary drop typically only impacts the ‘investment return needed to reach goals’ by less than half a percentage point due to time horizons.”

Katie Stokes, Director of Financial Planning at J.E. Wilson Advisors, LLC in Columbia, South Carolina agrees. She says, “We define risk as the chance that you will not meet your goals. Risk is living longer than your money. Volatility fails as a definition for ‘risk’ because the real ‘risk’ is outliving your resources. For example, a Certificate of Deposit has low volatility, but carries incredible purchasing power risk – meaning you are almost guaranteed to lose to inflation and rising costs over the long term. In terms of outliving your resources, CD’s are incredibility risky – much more so than a well-built stock portfolio.”

To discover the folly of volatility, read: “A 401k Fiduciary Dilemma: The Risk of Using Volatility to Define Risk

Aside from its purely mathematical significance, incorporating the GOT discipline also helps in terms of investor psychology. Anthony Alfidi, CEO of Alfidi Capital in San Francisco, California says, “Using a GOT keeps investors focused on the long term. They need to stop worrying about the ‘risk’ of short-term swings in asset values.”

Alfidi is by no means alone in his assessment of using GOTs. Jamie Hopkins, Esq., Assistant Professor of Taxation in the Retirement Income Program at The American College in Bryn Mawr, Pennsylvania, and Associate Director of the New York Life Center for Retirement Income likes the idea of focusing on a single GOT – and whether or not you can achieve that – as the benchmark for investors. He goes a step further, though, when he indicts the intricate mathematical models commonly used by purveyors of MPT. He says, “When planning and investing for long periods of time, volatility as a measure of risk becomes less important. If you can ride out down markets you can ignore some of the volatility risk inherent with certain investments. Instead, focusing on the likelihood of failing to meet a specified goal-oriented target can be a better way to frame risk. For example, Monte Carlo simulations will give you the likelihood of meeting a projected outcome. While this can be extremely helpful in crafting a plan, it is usually not the best way to present the plan or strategy to the investor because it focuses on the percent change of success or failure of a particular strategy. Ultimately, this type of analysis misses out on how much you miss the target, either over or under.”

Speaking of mathematics, it is from that standpoint that the GOT is similar in concept to the how trustees manage corporate pensions. There, the GOT is called the “actuarial assumption.” The actuarial assumption is derived from a series of variables. Into this complicated cauldron goes data such as age, gender, life expectancy, expected rates of return and prevailing interest rates. And out comes this magic number. The fact that it’s called an “actuarial assumption” should give you a hint as to the degree of confidence people have in it. That’s because the source of all this data is an ever-changing hard-to-pin-down population. At best, it’s a really good guess on how things should turn out. Given this uncertainty, trustees will often ask professional money managers to manage the portfolio to this particular number.

Similarly, one’s GOT can also be calculated using a complex set of variable. “The GOT must be liability-driven over a specified timeline,” says Alfidi. He compares calculating a GOT with pensions when he says, “Longitudinal demographic studies matter as the ultimate underpinning of liability-driven investing for pension plans.”

Creating a Goal-Oriented Target needn’t be rocket science. This is especially true for retirement-oriented goals. As we mentioned at the outset, there is plenty of demographic history to give everyone a good sense for their own personal retirement Goal-Oriented Target. It’s only a matter of identifying the right numbers. Conard says, “We simply start by picking an age in which they would like to retire. As long as the date doesn’t move significantly, their portfolio allocation shouldn’t either.”

Beyond retirement, though, calculating a GOT can get tricky. “In order to figure out what an investor’s target should be,” says Hopkins, “you need to understand where this investment fits into the overall financial plan and strategy of the investor. Is this investment being used to generate future income or is it being used to generate wealth? These are important questions that help determine how the investment strategy should be derived for a specific goal.”

Still, using the GOT process for non-retirement goals does help and, given simple goals, can be straight-forward and easy to understand. Joseph Carbone, Jr, Wealth Advisor and Partner at Focus Planning Group in Bayport, New York says, “The emphasis is placed on what the client is trying to achieve rather than what is going on, for instance, with the S&P 500. To take an example, if a client has a short-term housing goal, it is not relevant how the S&P 500 is performing compared to the client’s short term investment goals.”

Overall, Boersen sees GOT as a useful method for reframing the idea of what’s important, especially for retirement investors. He says, “Getting people to think about goals as opposed to short-term returns is helpful as it changes their viewpoint. The investors with short viewpoints are the ones who typically act contrary to their long-term financial success. By refocusing on long-term goals we take the focus off of day to day, or even month to month movements. Our retirement planning focus typically helps clients refocus on the long-term.”

Want more? Then read: “Why Every 401k Fiduciary Should Redefine Risk as What Happens When You Miss Your Goal

Stokes warns even a well-documented GOT is no guarantee of success. Still, she prefers it to another popular form of portfolio construction. She says, “You may have a ‘target return’ that is necessary to meet your goals, but there is nothing that will guarantee that you will meet those goals. There is no such thing as a future fact – the future is unknowable. However, backing into a proper allocation based on how much volatility and return you may need makes much more sense than focusing on what you can tolerate. Using ‘risk tolerance’ alone to decide a proper portfolio is not just wrong, it’s damaging.”

Charles Murphy, VP & CFO at American Investment Services, Inc. in Great Barrington, Massachusetts, prefers speaking to clients “in terms of failing to meet a goal rather than just volatility as an advisor can speak about how you might not reach that goal given the current specific investments or investment plan or lack of. Goals give an investor a clearer plan and picture of how to get where they want to go rather than just speaking about reducing volatility for return.”

Matthew Grishman, Co-Founder, 401kMasters, a subsidiary of Gebhardt Group, Inc. in Lafayette, California likes the GOT process because it can gives clients something they can really get their hands onto. “Simply put, it makes it real,” he says. “When the industry uses fabricated or misleading jargon like ‘volatility,’ most people just check out and do nothing. When we tie risk to real-life objectives, or failure to meet those objectives, it becomes a priority to handle the risk and minimize it.”

Carrillo takes a methodological approach when determining a client’s GOT. “I ask investors about their dreams and goals,” he says. “I then calculate the income they would need in today’s dollars, and then factor inflation to arrive at the rate of return and savings needs necessary to reach their goals.”

In the end, calculating one’s GOT may be as simple as using a specialized retirement calculator. “The absolute best way to derive their goal-oriented target,” says Travis W. Freeman, President at Four Seasons Financial Education in St. Louis, Missouri, “is by way of a financial plan, or at the very least, a retirement calculator. This ‘hurdle rate’ then helps them understand what return must be accomplished to achieve their goals. It also helps them understand that if too much risk it taken and things go awry, their goals may need to negatively change.”

Since at least the 1990s, most 401k plan investment policy statements have incorporated the “lessons” of Modern Portfolio Theory. In doing so, they integrated into their plan menu options – whether they knew it or not – the concept that volatility meant risk. Indeed, much of today’s participant education programs continue to date back to that era, and investors are taught to look at their risk before all else. We now know this old paradigm has been replaced by a new paradigm that focuses on the investor’s return requirement or Goal-Oriented Target. If 401k plan sponsors have failed to update both their plan menu options and their education program to this new paradigm, they may have unknowingly placed their employees in peril.

Is this a risk any fiduciary would want to take?

Mr. Carosa is available for keynote speaking engagements, especially in venues located in the Northeast, MidAtantic and Midwestern regions of the United States and in the Toronto region of Canada.

Interested in learning more about this and other important topics confronting 401k fiduciaries? Explore Mr. Carosa’s new book 401(k) Fiduciary Solutions and discover how to solve those hidden traps that often pop up in 401k plans. The book also contains a series of chapters on this subject, including how to create an investment policy statement that defines a set of menu options consistent with the new pardigm.

About Author

Christopher Carosa, CTFA

Christopher Carosa, CTFA


  1. Anthony Alfidi
    Anthony Alfidi January 26, 01:40

    Thanks, Christopher. I still believe that the Goal-Oriented Target (GOT) approach is effective. The increasing use of target-date funds in 401(k) plans makes it more imperative for finance professionals to formalize this method.

  2. Christopher Carosa, CTFA
    Christopher Carosa, CTFA Author January 26, 10:52

    Not only do I agree whole-heartedly with what you say, but I’ve just written a book about it. It’s called “Hey! What’s My Number?” and you can order it from Amazon or your favorite book store now. BTW, the “Number” in the title refers to the GOT.

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