What are the benefits of target date funds?
As the design of defined contribution (DC) plans like 401ks and 403bs have evolved, so have the investments. Features like auto-enrollment and auto-escalation made popular by the 2006 Pension Protection Act have grown in tandem with target date funds (TDFs) as the most common default option or QDIA. So what’s the role of TDFs and how should plan sponsors select the appropriate one for their employees?
Ruthann Pritchard, Institutional Portfolio Manager at Fidelity Investments, discusses the evolution of plan design and the role that TDFs play as well as the benefits of target date funds. Most participants are not equipped or eager to take on the task of designing and implementing an investment strategy to save for retirement. TDFs take the burden off of investors by creating an age appropriate asset allocation that changes over time becoming more conservative as people get close to retirement.
Unlike most other investments which are used to create an investment portfolio, TDFs are an all-in-one investment strategy designed to replace income in retirement for what will be most people’s longest period without a paycheck. The key element of the TDF is their glide path or how much risk is taken and when with income replacement in mind.
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And unlike other investments, TDFs involve a three-way relationship between the:
- Plan Sponsor – Who designs a plan and selects investments to maximize income replacement.
- Participants – Who must join the plan.
- TDF Provider – Creating appropriate investments for the company and their employees.
So how should a plan sponsor pick a TDF since most plans only use one target date suite which includes a series of funds in five-year increments? The DOL supplied some tips in 2013 which include:
- Understanding the objectives of the TDF investments.
- Making sure those objectives align with the company’s employees by;
- Demographics
- Behaviors
And because the world is evolving over what will be decades of investing for most people, TDFs must also evolve to meet the diverse needs taking into account the changing investment environment. Selecting a TDF is the most important investment decision plan sponsors can make so make sure there is prudent and documented due diligence process usually with the help of an unbiased third party professional like your advisor.
