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Making Better Investors:
Are Asset Allocation Models The Next Step In Retirement Savings?

The Players

• 401kForum
  www.401kForum.com
  Based in San Francisco and now reorganized as a unit of Emergent Advisors. The firm is located in the SOMA district of San Franciso -- an area associated with hot dot com firms. Its founder, Drake Mosier, came from Smith Barney where he was familiar with the brokers "TRAK" program. Ted Benna, widely noted as the "father" of 401(k), sits on the company's board.
  
  
• Financial Engines
  www.financialengines.com
  A prototype Silicon Valley tech startup of the Nineties. Located in Palo Alto just down the road from Stanford University and the offices of Professors William Sharpe and Joseph Grundfest who reportedly hatched the concept for the idea in a Stanford cafeteria. CEO Jeff Maggioncalda is a twenty-something with a Stanford MBA. The company also boasts a high profile board featuring Olena Berg Lacy, who formerly headed the PWBA.
  
  
• Rational Investors
  Founded by Francois Gadenne and Ben Williams. CEO Gadenne hails from BankBoston and Arthur D. Little where he was team leader of the group that developed a weather forecasting expert system for NASA following the loss of the Challenger space shuttle. Williams, programmer, developed the DOS memory extender in his previous job. The pair sold the Rational to Standard & Poor's, a unit of McGraw-Hill, this year.
  
  
• Ibbotson Associates
  www.ibbotson.com
  Founded by Yale professor Roger Ibbotson, the Chicago-based firm has a long track record as a consultant to the pension and investment community. First moved into the advice market as the developer of the advice model for TCW. Has since provided its capabilities to education firms including Weisenberger and Newkirk.
  
  

The Rest of the Field

• TeamVest
  www.teamvest.com
  A Charlotte, NC-based administrator and recordkeeper serving the small plan market and founded by executives from TrustMark. Recently formed an alliance with Intuit to provide advice through Web portals.
  
  
• Investment Technologies
  www.invest-tech.com
  A New York-based firm founded by Brian Rom in 1986. IT announced its entry into the 401(k) advice area in 1998.
  
  
• DirectAdvice
  www.directadvice.com
  A Hartford, CT-based startup that initially targeted the retail investor as Mentum. It has raised money from Japanese investor SoftBank Group and is said to be eyeing the 401(k) market. It is also rumored to be working with E*Trade, which has also raised money from SoftBank.
  
  
• AdvisorNet, LLC
  www.avisornet.net.com
  Owned by Chicago-based Marquette Associates this service was announced at the end of 1998.

First, A Little History

The advice firms are basing their business on a simple premise: technology - specifically the Internet - now allows the efficient distribution of top-quality investment advice to the average individual with an account balance in the low tens of thousands of dollars.

Taking the idea one step further, these firms targeted the defined contribution system as the ideal market into which to launch the advice concept. Unlike the retail advice business in which customers would have to be won over one at a time in what amounts to expensive trench warfare, the retirement plan industry held out the promise of a relatively quick sale to the plan sponsor. The plan sponsor would then act as the distributor of the advice to its employees.

For revenues, the advisors' business plans typically called for payments based on the number of participants in the plan. Usually, the hoped for fee landed somewhere in the $30 to $50 dollar range.

Through 1996 and 1997 the first wave of advice firms built their business based on these ideas. The two leaders down this path were Financial Engines and 401k Forum.

On the East Coast Rational Investors was working on a similar product with a different distribution twist. Rational's plan called on selling its product to bundled 401(k) provider rather than directly to the plan sponsor.

Meanwhile, Trust Company of the West (TCW) took a third path. The investment manager applied for and received a prohibited transaction exemption from the Department of Labor to provide advice to 401(k) participants. TCW's model was to offer a series of seven asset allocation funds to plan sponsors. TCW would then use a model developed by an independent advisor (Ibbotson Associates) to direct participants to one of those investment options that best fit their needs. Unlike the other firms, TCW would be paid an asset-based fee from the funds.

In November of 1997, Fidelity helped kick off the excitement over advice when FIRSco head Bob Reynolds held a press conference in New York City to introduce the concept to the media. Fidelity was careful to stress, though, that Portfolio Planner was not technically advice even though it picked specific funds for participants. Think of Fidelity's product as "aggressive education."

Fidelity's announcement both put advice on the map as a must consider feature of plan design. At the same time it had the effect of freezing the market as rivals waited to see the DOL's reactions to Fidelity's step.

The Rollout

If 1996 and 1997 were the planning years, then 1998 was the year that these products started to hit the street. Early adopters include Fujitsu and the SouthWest Airlines Pilot Association who signed on with 401k Forum and Alza Corp. which served as a beta site for Financial Engines.

What become apparent early on, though, was that few plan sponsors are willing to pay $30 to $50 per year for their employees to use one of these services.

Another hurdle for plan sponsors was their concern that they not increase their own fiduciary liability by offering one of these products.

The solution to these issues was for the advice firms to build alliances with bundled vendors to distribute the service to their plan sponsor clients. Key alliances were made by Financial Engines (Hewitt Associates, SSgA, Merrill Lynch), 401k Forum (Aetna, Hewitt Associates, Credit Suisse Asset Management), and Rational Investors (Pan American Life).

These alliances are good news in the opinion of Michael Gazala, research director at Forrester Research, Inc. (a technology-consulting firm). He believes that they "demonstrate that 401(k) vendors have put their stamp of approval on advice. This is definitely a plus," he says. "And since the advice-givers like Financial Engines and 401k Forum have knocked out multiple alliance deals with different plan providers, they are not in danger of losing their independence."

Steve Deschenes, president & coo at 401k Forum Deschenes feels that the alliances are only one mode of distribution, but there will be other models as well. He even forecasts that advice might be something that an individual participant could sign on for directly, but cautions that selling advice at the plan sponsor level made it more reasonable.

"This is the beginning of something pretty profound," contends Jeff Maggioncalda, president and ceo of Financial Engines. "Within six months, over 50% of the top ten vendors will have relationships with advice firms. In fact, that will extend down the line to top 25. It will be extremely common for 401(k) providers to partner with third party advice givers. The driver here is not that sponsors have realized that employees want advice. They already knew this. But sponsors now realize that advice is the good and safe thing to do." Optimistically, he adds that the trend is moving in the right direction. "The question is no longer is it too risky to offer advice, but whether it is too risky not to," says Maggioncalda.

Still, even as the number of alliances has mushroomed, and advice has become a part of the 401(k) request-for-proposal checklist, few plan sponsors are yet offering the service to clients.

The Present

A survey by Fidelity Investments of 1,116 participants in its system shows just how important the Internet is becoming to the average participant. "The Internet is now a mainstream account management channel for retirement savers. In fact, the volumes of contact 401(k) participants make through our online channel, NetBenefits, is exceeding the number of phone calls to retirement representatives. Virtually all 6 million participants serviced by Fidelity are Internet-enabled and we receive some 100,000 online contacts daily," states Kathryn Hopkins, executive vice president at the firm.

Fully 500 of the 1,116 surveyed use the Internet for personal finances.

• 85% use the Internet to check stock quotes,
• 75% use it to check their 401(k) balances,
• 49% use it to perform 401(k) transactions,
• And 36% use it for calculators and other online tools for retirement planning.

Fidelity expects usage of its online services to increase in the near future.

"We've made tremendous progress in the online channel in a very short period. As we work with plan sponsors to provide innovative tools such as PortfolioPlanner to assist with asset allocation strategies and expand the participant service features of NetBenefits, we expect the online channel to continue its meteoric rise," contends Hopkins.

Yet, today few Fidelity clients use Portfolio Planner. TCW, which obtained a prohibited transaction exemption, is no longer heard from and the independents Financial Engines and 401k Forum (now renamed as Emergent Advisors) are adding venture capital, employees, and alliance partners at a furious rate. Still, few plan sponsors have taken the plunge after facing the issues of cost and liability.

The Future

The recent announcement by TeamVest that it has joined with Intuit to offer advice through Intuit's Quicken portal and the Excite@Home portal (Intuit provides the financial area to Excite.com) marks a turning point in the evolution of advice. TeamVest's strategy is to use the portals to go straight to the user of the product -- the individual.

Financial Engines seems to be following a similar path. It recently revamped its website from a brochure targeted at corporate clients, partners, and investors into a retail site that delivers its Advisor product directly to the individual for $14.95 a quarter.

Financial Engine's Maggioncalda believes that when individuals need advice with 401(k) plans, the hurdle they are trying to leap across is not 401(k)'s but investing in general. "And needing help and advice with investing is the same whether we are talking about 401(k) plans, IRA's, or brokerage accounts," he opines. "Clearly, the investors who participated in the third round of financing at Financial Engines perceive the need and the opportunity that goes beyond 401(k)," Maggioncalda continues. "It's just starting."

"Advice will not stay focused on 401(k)'s," contends Forrester's Gazala. "Look at all the providers starting in the defined contribution space. They are answering a finite problem. Retirement is a finite goal. These providers will be looking to offer services in other financial areas. They will be exploring how their services can made available to a larger segment of the population, a segment that may never have had these kinds of products before."

"This will put a real pressure on human consultants, advisers, and brokers. They will now be challenged by the advice that is being provided online. They will have better educated customers. Individuals will not depend exclusively depend on Internet advice, but they will use it as a sounding board to get that second opinion," Gazala opines.

"Advice, though, is here to stay," the consultant concludes. "People still need help in making financial decisions. And they need that help regardless of whether they do not have the time, the interest, or the knowledge -- which are all good reasons."

Ray Martin, principal at SSgA, also sees a bright future for advice, but he does have some concerns about the means of how that advice is communicated. "Participants need help and advice. How do you define a benefit from a defined contribution plan? This is no longer the old days when your employer picked your investment options for retirement. You have to make your own choices. And people want to know how to do that. And it is important that they know how to do that."

"Where I have questions is with communications. If you just do advice over the Internet, you are locking out a large number of people. A 401(k) provider should be trying to reach as many people as possible. That is why there is a need for both telephone call centers and Internet applications. Some people need a dialogue with a real person, an adviser. Why do people put their book orders into Amazon.com and then call one of that company's sales representatives to make sure the order has been received? Because there is a need for dialogue and human interaction that no advances in technology will cause to go away," Martin argued.

"There is one computer for every three households in America. That means two are without. You cannot cut those people out of the loop," he continues. "What I like about the Financial Engines service is that it offers our participants an array of probable outcomes," Martin states.

Steve Deschenes, president & coo at 401k Forum, shares some of Martin's concerns about communications. "As much as we believe in technology, we need to look beyond the Internet as the sole means of communicating with participants. We have been developing our telephone and paper means of communication. As this market develops, there will be a wider cafeteria of products with different price points. It will become a more segmented market and a more complex one," says Deschenes.

"You have to look at trend lines in terms of participation utilization. Participants use advice and have been incredibly satisfied with it, much more than with other elected benefits. And providers are reacting to the demands of participants," he continued.

401k Forum believes that advice will be ubiquitous in five years. "Like daily valuation, it has a period where it needs to be initially accepted. Then it will become the must-have product."

Deschenes also predicts that advice has applications beyond 401(k) plans. "Initially, 401k Forum will be expanding our advice into IRA roll-over markets, 457 plans, and 401(a) plans. And then we can expand into other areas as well," he stated.

The official also sees global applications. "One of the things we are exploring marketing of our services in countries like Japan and the United Kingdom where they are developing a 401(k)-like system," he concluded.

But there are those who sound a note of caution about advice as well.

"It is now a given that participants need advice," says Mark Davis, president and founder of Mark Davis Consulting (a California consulting firm that specializes in education for sponsors). "There is still a split as to whether or not sponsors need to be giving it. Sponsors have not been educated enough on advice. And there is still a mismatch in terms of content and delivery. Those who need advice the most are the ones who have the least chance of accessing it."

"Another current problem is that most advice systems are not actionable," Davis continued. "Once the participants get the advice they need, they cannot act on it. That is a spot where the system falls down. The participant has to go to another website or pick up the telephone or go to the human resources officer. This is a definite area for improvement."

"And the industry has allowed itself to think that online advice is the answer to all problems. That is not the case. You still need education. I think when you have told someone what to do, that advice should be wrapped in some kind of education so that participants have a context of understanding," he argued.

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