VIEWPOINT: Target Date Funds: Popular Doesn't Mean Adequate

Our third video in our Proteus Viewpoint video series, Target Date Funds: Popular doesn't mean adequate.

For further information on target date funds, read the below Q&A.

As a defined contribution plan member, what are the two critical decisions you must make in assuring an adequate retirement?

As a DC plan member, you have three decisions to make to help ensure you have enough saved for retirement. You should decide: how much to save, how to invest and how long to invest for.

How do you invest?

Target date funds (TDFs) were created in the last decade, or so, and are becoming increasingly popular, often designated as the default option for many plans. In the US, assets in TDFs rose from a total of $100 billion in 2005 to over $700 billion in 2015, and more than 60% of new defined contribution (DC) pension contributions are now flowing into these funds.

A TDF is a diversified portfolio, so it will typically have a wide range of stocks and bonds, which become less risky over time. For example, the fund for a 25 year-old will become less risky as the member ages and by the time they turn 60 the fund will have significantly less risk than when the member first invested.

What are the advantages of TDFs?

TDFs allow members to make a simple decision based on their age or number of years expected until retirement. The investment then automatically rebalances toward a more conservative asset mix as retirement approaches. The logic here is that, at a young age, an investor has more time to ride out the ups and downs of the stock market and can benefit from the long term expected rate of return.

What did members do prior to TDFs?

Prior to target date funds, DC members were often faced with either too few or too many investment choices. On the one hand you could have the plan member try to figure out how much to put into stocks, bonds or GICs, or they would invest in a balanced fund or asset allocation strategy with an asset mix that didn’t change much over time.

How can you help members make appropriate diversified choices?

First and foremost, plan sponsors are expected to provide investment options that will allow plan members to invest according to their personal risk tolerance and goals. To do that, the plans may offer balanced funds as part of the lineup. The challenge with balanced funds is that the asset mix doesn’t materially change, which means the risk profile may be appropriate for someone at age 30, but it won’t change as the member ages. The reality is that most members rarely rebalance or change their allocations over time, preferring to stick with their original allocation decision. In other words, the investment decision they make at 30 may still be in place when they are 50.

What issues do target date funds address?

Although not perfect, because TDF’s automatically become less risky over time, the fact that plan members may not pay attention to their investments doesn’t matter as much because the portfolio is automatically changing for them.

Interestingly, TDFs are now also a common default option in DC plans and typically garner the newest contributions.

What are the disadvantages of TDFs?

The disadvantages of the TDF structure are that they tend to be more expensive than other options. They also assume all participants in the fund have the same risk tolerance and that the plan member does not control the asset mix.

Are TDFs the perfect solution?

TDFs may not be a perfect solution for all plan members but they are a real step forward in simplifying the investment decision. For plan members that want a ‘set it and forget it’ option, TDF’s can really fit the bill.

For more information on what target date funds are available for your plan or to learn more about the solution, please contact your Proteus consultant.