With 90% of new 401(k) contributions expected to flow into target date funds (TDFs) in 2019 according to researcher Cerulli, the selection of a TDF for their defined contribution (DC) plan is perhaps the most important decision an employer sponsoring a DC plan will make after selecting the right plan advisor. Yet plan sponsors and their advisor often make the mistake that benchmarking TDFs is the same as with any other investment.
There are many aspects that differentiate the over 50 mutual funds TDF options which make it different than simply comparing a fund’s 1-3-5 year performance against their applicable benchmark as well as fees. TDFs differ based on their:
- Glide path – the amount of risk they take as they get closer to the projected retirement age and whether risk taking is continued “through” or “to” the retirement age.
- Asset Allocation – the types of investments included.
- Underlying Investments – the actual ingredients.
Think of baking a cake – the glide path is the type of cake you want; the asset allocation is the recipe; the underlying investments are the ingredients. Is German chocolate cake better than strawberry shortcake? It depends on the audience. Is your employee base older or younger, risk averse, higher or lower salaried, have high turnover, take out loans or tend to leave money in the plan when they retire? Unlike other investment options available to allow employees to bake their own cake, TDFs are one for all.
So what’s best? That depends – 401kTV posted an article by Dorann Cafaro on the subject and SHRM published a supplement explaining TDFs with a list of the top 20. A plan’s advisor will work with the employer’s HR and financial professional to find the right 5-7 funds that meet the profile of the employees and then look to see how they perform over different markets reviewing the process, not just performance. Did a TDF do well just because it had high exposure to stocks during a bull market? How did it perform in a bear market compared to similar funds?
