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Target Date Fund Are all Created Equal, Right?
In recent years, target date funds have exploded in popularity. These funds were created primarily to manage risk and create simplicity for employees participating inside of employer sponsored 401(k) retirement savings plans. The principal concept behind target date funds is that risk should be lower for investors as they get closer to retirement. This objective is implemented by changing the asset mix of stocks and bonds, since the underlying principle is that when one approaches retirement, the portfolio should have an increasingly conservative allocation of assets.
Until now, many have viewed target date funds as a homogeneous style of investment; that all target-date funds of the same retirement date (i.e. 2010) are similar regardless of vendor. Most employers and employees probably have come to a similar conclusion.
However, target date funds are not created equal – as we saw in 2008, when many experienced very poor performance, as seen in the following press accounts.
Financial Planning magazine, February 2009: “More warts have been laid bare after last year’s market meltdown. For instance, depending on which 2010 fund they were in, an investor looking to retire next year could have lost as little as 4 percent in 2008 or as much as 41 percent. One reason for those widely varying returns: The stock components of the 2010 funds that Sen. Herb Kohl’s Senate Special Committee on Aging recently studied ranged from 8 percent to 68 percent.”
Investment Advisor Magazine, March 2009: “Target date funds, on average, were down 25% last year, with 2010 funds dropping 25% to 30%. Attorney Fred Reish of Reish Luftman Reicher & Cohen in Los Angeles, which specializes in employee benefits law, says that given the poor performance of target date funds, advisors need to be “talking with plan sponsors much more about their target date funds, how they performed last year, and see if that’s what the plan sponsor wants.”
The Associated Press, May 17, 2009: “Target-date mutual funds are supposed to simplify investment planning by automatically dialing down risk as you approach the day when you can finally call yourself retired. Yet the recent market meltdown exposed how funds with the same target date can yield wildly different results. For investors with the freedom to pick among the more than 40 companies now offering target-date products, good luck. The asset mixes in funds that attempt to ease you toward the same retirement date vary so widely that they defy simple apple-to-apple comparisons. Plus there’s a lack of easy-to-use tools to see how one fund stacks up against the next.”
The New York Times, June 24, 2009: “Washington blessed them as a way to put your 401(k) on automatic pilot and glide safely toward retirement. But popular target-date mutual funds have badly missed the mark — and now regulators are asking why. Labor Department officials evidently found the concept persuasive. In 2007, they issued an unusual rule that protects employers who automatically send workers’ 401(k) money to target funds if, later, the employees lose money. That so-called safe harbor unleashed a flood of money into the funds. But as the stock market plummeted last year, some 2010 funds — which many investors thought would be invested safely by then to protect their nest eggs — lost 40 percent of their value. That showing was even worse than that of the Standard & Poor’s 500, which fell 38.5 percent.
The Wall Street Journal, July 4, 2009: “Given the dramatic, wealth-killing market Crash of 2008, it’s not surprising that target-date funds faced a lot of criticism in recent months. Some of these so-called set-it-and-forget-it retirement vehicles lost investors as much as 40% of their savings last year. But that’s little solace for people planning to retire in 2010, many of whom may be forced to delay their plans now that they’ve seen one-quarter or more of their savings vanish. The five-biggest 2010 target-date funds lost an average of 29% from the start of the market’s fall in mid-October 2007 through March 9 of this year.”
As the employer, you can see how convoluted target date fund industry has become in its short life ranging from how portfolios are constructed to how participants view the funds themselves. There is confusion at all levels to include the fund industry itself, plan sponsor and employee alike. Here are 10 questions you should ask yourself.
- 1. How was your target date fund family chosen? What process if any did you create and then follow in choosing your existing target date fund family?
- 2. How was this decision-making process communicated to plan participants? Did you communicate with them at all? If so, was the decision-making process described to them?
- 3. What is the amount of equity allocation at retirement? Whether the allocation is high or low, employees must know how much equity exposure they will have at retirement.
- 4. Number of asset classes? As a general rule in diversification, more asset classes tend to offer more diversification from risk than fewer asset classes.
- 5. Income or growth? Is the target fund at retirement trying to generate income for
- the near-retiree, or is it continuing to manage long-term growth to mortality?
- 6. More or less volatility? Is the target date fund at retirement objective to lower risk of account flucuations (volatility) or continue to manage asset growth to mortailty?
- 7. Does the program seek to maximize the participant’s savings to retirement or to the end of life? Employees need to know which goal their target date fund family is seeking to accomplish.
- 8. Do you prefer target date strategies seeking to minimize downside risk or seek to maximize upside return potential?
- 9. Do you believe that diversification can be achieved primarily with traditional asset classes such as stocks, bonds and cash? Or do you believe diversification can only be achieved by extending beyond traditional asset classes?
- 10. Review your current target date fund offerings. Is the current program offering what you want? Do you know what you want? Do your employees know what they have?
Which Target Date Fund family are you?
It may be time to realign your target date fund portfolios. You should create a written process for initial and ongoing monitoring of target date funds. Communicate that process to employees.
We can help.
David Gratke Wealth Advisors, LLC has the tools necessary to engage plan sponsors to monitor and manage their company’s target date fund program. Contact David Gratke to begin the review process. We look forward to discussing this matter with you.
Additional articles on recent Target Date Funds:
No Quick Recovery for Hard-Hit Target Funds, WSJ June 4, 2009
Target-Date Mutual Funds May Miss Their Mark, NYT June 25, 2009
Funds resist regulation of target date pensions Financial Times, July 5, 2009
Failure of a Fail-Safe Strategy Sends Investors Scrambling WSJ, July 10, 2009
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