Most people I talk to haven’t taken a class on retirement planning, much less 401(k) investments like a QDIA. A QDIA — qualified default investment alternative — is where a 401(k) puts your money if you don’t select investments. Yet most employees don’t remember reading about QDIAs in whatever packet the HR department gave them about their retirement plan. So how do you know if your plan has a QDIA, or if have money in one? Here’s what you need to know about QDIAs and your money.
A quick 401(k) history lesson
When 401(k)s first rolled out in the 70s, they offered very few investment choices. To this day, they are only legally required to offer three types of investments, or asset classes: stocks, bonds and cash. The choice of three asset classes pulls from Nobel Prize winning economic research. The research says you can derive a wide variety of outcomes just by using different combinations of these three.
Think of it as cooking with salt and pepper. By changing the proportions, you can create a myriad of flavors. A two-to-one ratio of salt to pepper tastes wildly different than an 82-to-one ratio of pepper to salt.
These days, many retirement plans offer participants significantly more than three choices. But more choice isn’t always better. It can overwhelm the decision-maker and lead to indecision. And if indecision means the employee doesn’t select any investments, then what?
All this confusion led the government to develop a new standard called the qualified default investment alternative.
How qualified default investment alternatives help
In the past, some plans defaulted employee contributions into some type of cash account if they didn’t select investments. This wasn’t ideal. Most people don’t have the luxury of saving for retirement with cash. While people may not like the ups and downs of the stock market, they need the boost of investment returns to help grow their money.
To help the investor, and the employee, the government developed something called a qualified default investment alternative. They allowed for three choices: a balanced, a risk-based, or a target date strategy. Using our salt-and-pepper analogy, a balanced strategy typically has about 50 percent bonds and 50 percent stocks, or a one-to-one ratio. The risk-based strategies use varied combinations of stocks, bonds, and cash to create a target level of risk. (Stocks are generally considered riskier than bonds.) Finally, a target-date strategy recognized that investors generally tolerate more risk when they’re younger and prefer to avoid it as they approach retirement. So target-date funds automatically rebalance their stock-to-bond ratio to reflect a changing risk tolerance. While there is a certain logic to the target date strategy, few investment managers agree on the ideal ratio of stocks to bonds at any given point.
In terms of which QDIA your 401(k) uses, that’s up to the plan sponsor: your employer.
Is a QDIA costing you money?
If you contribute to a 401(k) and you never selected investments, chances are, your money is in a QDIA. Employers generally have good intentions when deciding the menu of investments you have to choose from in a 401(k). That includes the QDIA. But as we mentioned earlier, there’s no gold standard in terms of how to build a target-date fund, and a balanced strategy may not be right for you.
Start by finding out exactly which one you have. If you never picked investments and you don’t have a QDIA, find out what kind of account your money went into. I recommend seeking out a financial advisor with retirement planning credentials that can help you figure out if your money is invested in a way that will work for you. If not, the advisor can help you select different investments in your 401(k) plan that better suit your needs. Under current legal standards, this person must be an investment advisor representative obligated to work in your best interest (fiduciary).
If you’re ready to start the conversation assessment of your risk comfort level, start here.