Target Date Funds: Can Employers Get Lost in Space?
People often say to shoot for the stars, because if you miss you’ll at least hit the moon - which is easy to say if you aren’t an astronaut! An astronaut would probably tell you that if you miss your target you’re not likely to land on the moon, but in the vast emptiness of space, drifting longer than planned and hoping your supplies will last is hardly a successful mission.
Perhaps something similar can be said about our final financial frontier: retirement. Most retirees who miss their financial goals aren’t “landing on the moon” by any means, and by the time they know they’ve missed their target it’s too late to pick up the phone and say, “Mission Control, we have a problem.”
Why do so many miss the mark? Many don’t know how to invest properly. As a result, many employers who sponsor 401(k) and 403(b) plans have added Target Date Funds (TDFs) to their plan. However, employers need to know that selecting a TDF series involves more “rocket science” than may be initially apparent.
You see, Target Date Fund series are as diverse as the universe. Plan sponsor fiduciaries – who must exercise prudence and demonstrate expertise in selecting the investments that will be offered to plan participants – must understand the unique features of their workforce as well as the features of each TDF series they consider before making their selection. Failure to do so “as an expert” can result in potential personal liability for fiduciaries.
Employers who examine Target Date Funds closely will see they resemble a kind of retirement “shuttle.” Just as a shuttle launch must reallocate propulsion among its boosters and engines at specific intervals to sustain optimal propulsion in its trajectory toward space, a TDF series reallocates its assets among stocks, bonds and cash at specific intervals to reach an eventual retirement. And just as astronauts know that there are various trajectories by which to travel, Target Date Funds offer an array of different features that plan sponsor fiduciaries must understand in intimate detail in order to select the “right” series to meet the needs of their employees.
Here’s the thing: the allocation among stocks, bonds and cash; the “glide path;” the management philosophy (passive versus active and strategic versus automatic); and, finally, the quality of the underlying funds can vary dramatically from series to series. Some TDFs “launch” in a more risky and aggressive fashion, with returns ramping up quickly and later “coasting” gradually as they convert to more conservative allocations. For other TDFs the reallocations are not gradual; they change trajectory abruptly, in a dramatic step-like fashion. Others begin with significantly less risk, or have varying rates of fund diversity, fees, performance history, end dates and management philosophies. Some “glide paths” are inalterable – like a rocket on “auto pilot” – while others can be strategically overridden to respond to the market environment.
One more word of warning: The Department of Labor recognizes that employers’ mission to assist employees in becoming retirement-ready is often at odds with the mission of Big-Brand recordkeepers to maximize their revenue and have stepped up their review of the process employers use in selecting a TDF series. Many employers, when faced with a confusing array of Target Date Fund choices, simply select for their plan the series that is offered by their Big-Brand recordkeeper. Often this series is nothing more than a distribution vehicle for the recordkeeper’s proprietary fund products. While some of the underlying funds may be good, others may be new fund offerings or funds with poor past investment earnings experience.
As I meet with employers, I hear many express a sigh of relief after having added a Target Date Fund series to their 401(k) or 403(b) plan. They think they’re “home free.” As I’ve shown, that sigh of relief could represent a false sense of security – by turning to Target Date Funds, they may have at best created confusion for themselves and at worst opened themselves up to potential liability for selecting a TDF series that is a poor match for their workplace.
Employers who explore their options are increasingly finding better ones – in particular, providers who offer managed accounts. These risk/return “model portfolios” provide benefits for plan sponsors and employees alike. Look for my next blog in which I describe the way in which managed accounts make it easier for plan sponsors and better for employees. As an employer, you are “Mission Control,” with the goal of helping your employees both live long and prosper!
This blog is written to help make the lives of plan sponsors easier in the process of meeting legal requirements under ERISA for their defined contribution plans. Please understand that reading this blog should not alone take the place of a one-on-one consultation regarding the needs of your specific plan, and hence cannot be a guarantee against fiduciary breaches.