Using Target Date Funds? Better Check under the Hood!
For almost 20 years, Target Date Funds (TDFs) have provided investors a convenient way to map out a low-maintenance pathway to retirement. These funds have even become a popular option in 401(k) and 403(b) plans because they allow investors to funnel their retirement into a single fund that will rebalance and redistribute the money over various asset classes based upon the expected retirement age of the participant. As the participant gets closer to that date, the fund automatically changes its model percentages and become incrementally more conservative. Basically, the TDF sells itself because investors can “set it and forget it.” However, if you have these funds in your plan, you may want to check under the hood – you may be surprised at what you see.
For almost 20 years, retirement plan sponsors have offered Target Date Funds (TDFs) in 401(k) and 403(b) plans to help participants map out a low-maintenance pathway to retirement. TDFs remain popular today because they allow investors to conveniently funnel their retirement into a single fund that will rebalance and redistribute the money over various asset classes based upon the expected retirement age of the participant. As the participant gets closer to that date, the fund automatically changes its model percentages and become incrementally more conservative. Basically, the TDF sells itself because investors can “set it and forget it.” However, if you have these funds in your plan, you may want to check under the hood – you may be surprised at what you see.
The recent market downturn has brought to light several of the deficiencies of these funds, many of which have even caught the scrutinous eyes of the Employee Benefits Security Administration and the Securities and Exchange Commission. The following is a summary of some of the issues that have caused concern among investors and what you may need to identify if you offer TDFs.
Not All TDFs are the Same
One key concern is that TDFs are so diversified in their asset mix and risk, that investors expecting to retire soon can be blindsided with losses in what they believed to be a conservative approach to retirement. Investors with a retirement date of 2010 can choose from any number of TDFs, but they cannot expect to rely on any similarities in composition. In fact, investors should be aware that the range of equities exposure in target date 2010 funds is between 10%-79%. The effects of this discrepancy were glaringly apparent in 2008 when the average loss for 2010 TDFs was just shy of 25%, and the losses ranged from 4%-41%. This has been a significant shock to many investors who thought that they were invested very conservatively because they purchased TDFs based on a retirement target of just two years.
Risk Profiles are Ignored
Another major problem is that TDFs do not take the individual investors risk profile into account. Investors with a moderate risk profile who plan on retiring 2025, for example, may be surprised to find that their funds have equity exposure of 70-95% when their risk profiles say they should have no more than 50-60%. Many people may not be comfortable with that much exposure to stock, even if they aren’t retiring until 2025.
Questionable Fund Quality
Exacerbating the problems of the equity exposure can be the quality of the underlying investments in the fund. Most TDFs are a portfolio of mutual fund offerings from a mutual fund company, but investors should be certain that company is reliable and has a broad range of expertise across different types of stocks and bonds. Many fund companies often put their poorer performing funds in the TDFs in order to drive more assets to the fund. This practice can cause overall performance to be subpar.
TDFs can be a valuable part of any retirement portfolio; but if you are offering them in your plan, it is important to know what is under the hood – and it is especially important that your participants know as well. Because of the convenient automation features of TDFs, plan sponsors often neglect to educate participants on the nuances of the funds. You, as an employer, should take the time to understand what you have, and pass that knowledge on to your employees.
For more information, please click on the following links:
Target Date Funds Come Under Fire
Target Date Funds: Seven Questions to Ask Before Jumping In
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Important Notice: Hill, Chesson & Woody does not engage in the practice of law, accounting, or medicine. Therefore, the contents of this communication should not be regarded as a substitute for legal, tax, or medical advice.
October 23, 2009
Hill, Chesson & Woody strives to keep our clients' group decision makers abreast of trends influencing the employee benefits market. Look for Eyes on Benefits to bring you news and information affecting you and your employees.
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