The world of investing is a difficult endeavor, most individuals who direct their own investments sadly end-up losing money. Target date funds (TDF) are designed to offer professional investment management, age-appropriate risk profiles and re-balancing all at a low cost. It is no wonder that TDF’s are often used as the default option for 401k funds that have auto-enrollment.
A new study from the Retirement Research Center at Boston College entitled, “Target Date Funds: What’s Under the Hood” examines the construct of these funds in a detailed analysis.
According to the study a TDF is essentially a group of mutual funds managed professionally as a “fund of funds”. TDF’s also employ a mix of fixed income (bonds) exposure as appropriate as the participant nears retirement (glide-path). This is a basic explanation, but serves well as a single source solution for diversification.
Each
TDF has a “target” year and a pre-determined glide path for gradually reducing the equity allocation as the target date approaches. This structure reflects the conventional notion that individuals should generally have less exposure to equities as they age
TDF Fees
TDF’s have two layers of fees. Underlying fees, which are charged by the funds with the TDF (individual mutual funds) and management fees from the TDF managers (“overlay fees”). This is perhaps one of the more complex parts of a TDF. Fees can get a bit confusing as they are adjusted according to share classes and corresponding expenses. It is imperative that plan sponsors make their participants aware of the fee structures.
TDF Performance
According to the CRR report Alpha (a measurement of performance against a baseline index) on TDF’s is 20 basis points which, according to the report, “which is statistically significant. This return reflects the fees on the underlying funds but does not account for the overlay fee added by the TDF. When this fee is added – roughly 50 basis points on average – the total alpha is roughly -70 basis points”
The CRR report suggests the outlook for TDF’s will continue to dominate the qualified default selection and will likely become the largest investment vehicle in defined contribution funds in a matter of a few years.
