Skip to Content
Big Picture

Can a Dynamic Default Investment Be Right for Your 401(k) Plan?

How plan sponsors may be able to get the best of both worlds with this dynamic approach

Since the introduction of the qualified default investment alternative, or QDIA, about a decade ago, target-date funds have grown in popularity. That’s mainly due to their lower cost and ease of implementation. But despite their popularity, target-date funds often fall short when it comes to personalization. A managed accounts service can offer much greater personalization and advice, but it often comes at a higher cost.

So, what’s a plan sponsor to do?

The default investment decision is an important one, and historically, defined-contribution plans have been limited to choosing a single option. But a new, dynamic approach may help plan sponsors get the best of both worlds.

What is a dynamic default investment?

A dynamic default investment is the use of multiple defaults, such as managed accounts and target-date funds. The default investment varies by participants. And under such an arrangement, the plan sponsor could default participants into different benefits options based on certain criteria.

For example, a plan sponsor may decide to default participants into managed accounts once they reach a certain age (i.e. 50) while younger participants would be defaulted into target-date funds. This idea of a “dynamic” or “hybrid” default, where the default investment varies by age, is illustrated in the example below.

Source: Author. For illustrative purposes only and not indicative of an actual investment.

The dynamic default investment concept illustrated above shows how participants who were initially defaulted in target-date funds would move into managed accounts when they reach the transition point. In this example, it’s age 50. But a plan sponsor could use other attributes to divide participants, such as income, balance, or a combination of factors.

How does cost impact the dynamic default investment?

Cost is a key consideration when deciding the right default option for a participant. If the additional cost of managed accounts is relatively low, that could favor wider use of managed accounts. As the cost of managed accounts increases, target-date funds—or the alternative default option—becomes more attractive. So, the transition decision should not only be based on participant demographics and plan information, but also on the cost of the different options as well.

The future of dynamic default investments in defined-contribution plans

There are relatively few providers offering a dynamic default solution today, with Empower Retirement being among the first to announce a product and Fidelity also making an announcement shortly thereafter. We expect both interest and availability of these types of dynamic default solutions to increase in the future.

Please see below for important disclosure.

Read the full research paper "The Default Investment Decision: Weighing Cost and Personalization."
Get My Copy

Important Disclosure

Morningstar Investment Management LLC is a registered investment adviser and subsidiary of Morningstar, Inc. The Morningstar name and logo are registered marks of Morningstar, Inc. Opinions expressed are as of the date indicated; such opinions are subject to change without notice. Morningstar Investment Management and its affiliates shall not be responsible for any trading decisions, damages, or other losses resulting from, or related to, the information, data, analyses or opinions or their use. This commentary is for informational purposes only. The information data, analyses, and opinions presented herein do not constitute investment advice, are provided solely for informational purposes and therefore are not an offer to buy or sell a security. Before making any investment decision, please consider consulting a financial or tax professional regarding your unique situation.

Transparency is how we protect the integrity of our work and keep empowering investors to achieve their goals and dreams. And we have unwavering standards for how we keep that integrity intact, from our research and data to our policies on content and your personal data.

We’d like to share more about how we work and what drives our day-to-day business.

We sell different types of products and services to both investment professionals and individual investors. These products and services are usually sold through license agreements or subscriptions. Our investment management business generates asset-based fees, which are calculated as a percentage of assets under management. We also sell both admissions and sponsorship packages for our investment conferences and advertising on our websites and newsletters.

How we use your information depends on the product and service that you use and your relationship with us. We may use it to:

  • Verify your identity, personalize the content you receive, or create and administer your account.
  • Provide specific products and services to you, such as portfolio management or data aggregation.
  • Develop and improve features of our offerings.
  • Gear advertisements and other marketing efforts towards your interests.

To learn more about how we handle and protect your data, visit our privacy center.

Maintaining independence and editorial freedom is essential to our mission of empowering investor success. We provide a platform for our authors to report on investments fairly, accurately, and from the investor’s point of view. We also respect individual opinions––they represent the unvarnished thinking of our people and exacting analysis of our research processes. Our authors can publish views that we may or may not agree with, but they show their work, distinguish facts from opinions, and make sure their analysis is clear and in no way misleading or deceptive.

To further protect the integrity of our editorial content, we keep a strict separation between our sales teams and authors to remove any pressure or influence on our analyses and research.

Read our editorial policy to learn more about our process.