Last year my employer announced that my 401K retirement plan, offered through Fidelity, would support integration with Financial Engines. I first thought this was a company sponsored version of Edward Jones (a high commission financial advisor). I was surprised to learn that Financial Engines was actually more like a robo-advisor for 401Ks.
What is Financial Engines?
Financial Engines is the largest Registered Investment Advisory (RIA) firm in the country. It was founded in late 1990’s by Nobel Prize winning economist William Sharpe, Stanford Law Professor Joseph Grundfest, Attorney Craig Johnson and Jeff Maggioncalda. The advice they offer is based on Modern Portfolio Theory (MPT) which is a method to maximize portfolio returns for the amount of risk you are willing to take. They run millions of market scenarios called Monte Carlo simulations to understand how different portfolios will perform over time so you will have the best chance to achieve your retirement goal. For years they have provided portfolio management solutions for 401K retirement plans. Over time they have expanded their offerings to include both full-service human portfolio management as well as software automated portfolio management solutions. This company was a robo-advisor before robo-advisors started to become popular over the last ten years.
What do they offer for my 401K?
Financial Engines offers two options: they can provide recommendations that you can execute on your own (free) or they can take control and execute the plan automatically on your behalf (paid). The fees for the automated service differ based upon the agreement your employer has with Financial Engines. My company negotiated a graduated fee structure that charges 0.40% for smaller accounts and 0.25% for larger accounts. The service creates an optimal portfolio using the asset class options that are available through your employer’s plan. I compared their free recommendations with my desired portfolio allocation and found it was very similar except they were slightly more aggressive (they recommend fewer bonds and more small-cap stocks).
Fidelity already supports to ability to allocate new contributions with a percentage breakdown towards different funds. What they don’t provide is automatic re-balancing. This is where Financial Engines can help. Is that really worth 0.40% in management fees? I don’t think so. You can configure re-balance alerts in Fidelity and then do the re-balance yourself once or twice per year. If you have trouble doing the re-balance on your own then then you might consider this service.
I spoke with a Financial Engines representative and learned a few more details about their service. First, Fidelity only permits them to make portfolio changes once per month. This limits excessive automated trading and also ensures that the costs to operate the 401K plan remain low. The representative also said that the rebalances are triggered based on a drift of more than 5% from the target allocation of a given fund. They do not rebalance based on a fixed time interval.
Linking Outside Accounts
Financial Engines supports the ability to link outside accounts to your portfolio that is registered with them. This allows them to look at the holistic picture and recommend a 401K asset class allocation that accounts for your other investments including company stock.
My 401K plan supports the ability to make after-tax contributions apart from the normal pre-tax contributions. The after-tax contributions can then be converted into a Roth IRA account each year. This is known as an in-service conversion which means that I don’t have to wait until my employer changes to convert to an account outside my 401K plan with many more investment options. In order to keep the conversion process simple, I direct my after-tax contributions towards a target date fund during the year until I’m ready to do the conversion outside the plan. It’s best not to co-mingle the pre-tax and after-tax contributions in the same funds. This helps avoid complexity at the time of conversion. Unfortunately, Financial Engines’ automation service doesn’t understand this conversion capability and it will co-mingle your contributions. I discussed this with the Financial Engines representative and he recommended against using the automated service.
I’m a big supporter of robo-advisors and I do use a robo-advisor for my taxable portfolio. However, I do not recommend Financial Engines for two reasons:
- 0.40% management fee for what essentially boils down to automated re-balances isn’t a strong enough value proposition.
- The service doesn’t understand after-tax contributions and it will complicate the annual conversion process.
What are your thoughts? Would you use this service for your 401K?