Target Date Funds, Part 2: Participants Lost in Space?
Target-Date Funds can be a poor investment “shuttle” for plan participants, as eventually discovered by many employers who act as “Mission Control” for their corporate retirement plans. In meetings with 401(k) and 403(b) plan sponsors, I frequently learn that these employers believe they have successfully launched employees on a flight path toward retirement success by offering a Target Date Fund series in their plan. Unfortunately, plan participants invested in a Target Date Fund can find themselves financially “lost in space” when they retire, due to common misperceptions regarding TDFs, as well as the funds’ complex and often confusing nature. This backfires on the high hopes of employers to assist their employees in preparing for their financial futures.
In my last blog, I talked about the way in which the selection of a Target Date Fund series involves more “rocket science” than many employers suspect, how employers – as plan fiduciaries – must understand all aspects of the series and make sure it is a good match for the make-up of their workforce before they include it in their plan. To recap, each Target Date Fund in a series contains a mix of funds, whose allocation grows more conservative as the target date is reached. However, no TDF series is the same: they vary drastically in terms of their glide path, management philosophy, fund quality, and risk or aggressiveness.
While in my last blog I described how employers often experience substantial challenges in selecting a suitable TDF series, here I will focus on how an individual TDF can easily be a mismatch for a given participant, ultimately exploding the efforts of employers to assist employees in becoming retirement-ready.
The lack of retirement readiness is a well-documented and pervasive problem. Simply encouraging employees to get invested in a corporate retirement plan is often an uphill challenge for employers. Once employees are enrolled and saving, employers face a second challenge – making sure employees are properly invested.
Making proper investing easy becomes part of the mission of employers who want to make sure their employees will maximize their plan investment earnings to maintain their standard of living in retirement. While Target Date Funds may seem to offer an easy solution, selecting an individual fund does not guarantee a plan participant will be properly invested. Participants vary in terms of their financial situation, background and needs, and a Target Date Fund series differentiates among participants only in terms of their age.
When using TDFs, employers need to be concerned that employees select the right fund in the series to meet their situation. The simplistic approach that many employees take is to choose the fund that bears the date when they anticipate leaving the workforce. To best invest for retirement, employees need to consider various factors: their age, health, longevity, potential future health, level of financial literacy, current and projected future income, and other retirement investments.
Worryingly, some employees misunderstand the term “target” to mean that the fund they select will somehow grow in assets to meet their needs in retirement, and that the fund will reach a “target” value in terms of total assets. This is not the case; “target” simply refers to how those assets will be allocated among stocks, bonds and cash at the target date. In other words, TDFs are primarily calibrated to determine how employees’ retirement shuttle will land – not where!
Lastly, employers should keep in mind that their employees’ best interests may not be served if they select the Target Date Fund series of their Big-Brand recordkeeper, as many find it easiest to do. Because TDFs are made up of individual funds, these series are often nothing more than a distribution vehicle for the recordkeeper’s proprietary funds, some of which may be good but others of which may be new fund offerings or funds with poor past investment earnings experience.
Even if employers go “to infinity and beyond” in selecting the best TDF series, employees still need to match their own unique situation with the way in which their TDF series is constructed and “piloted.” Few participants have that ability, and often their closest form of assistance is a call center staffed by customer service representatives.
Simply stated, TDFs are too often antagonistic to the goals of both employers and employees. There is a solution, however: managed accounts. These model portfolios provide greater flexibility to both employers and employees, and have provided superior investment outcomes for participants as they make it easier for them to be properly invested.
In a future blog, I will delve deeper into the opportunities managed accounts provide. Please call or email me to discuss the challenges you face in managing your 401(k) or 403(b) plan to best serve your employees.
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.