Target Date Funds – Next Generation Default Options and Benchmarking. As a result of the 2006 Pension Protection Act, automatic enrollment was given safe harbor and target date funds were approved as the default option or QDIA (qualified default investment alternative). Target date strategies have become the single most popular investment for new contributions which means 401k and 403b plan sponsors should pay close attention to them. But benchmarking target date funds is different than with most other investments. And though popular, what lies beyond?
Because target-date funds are a fund of fund, have a longer time horizon and change risk profiles as investors get closer to retirement, there should be a different set of metrics to benchmark them compared with single strategy investments or capital preservation funds like fixed income or stable value. Work with your advisor to set up the right criteria for benchmarking target date funds based on the demographics and profile of your employee base.
And though target date funds have been effective, they only use one data point – age – to determine risk profiles which is why they are called QDIA 1.0. Next generation default options will use other data points like salary, account balance, deferral rates, gender, and marital status to determine risk profiles, called dynamically managed accounts. Costs have come down for QDIA 2.0 which automatically create portfolios and are starting to appear using data readily available on record keeper systems.
QDIA 3.0 will incorporate an investor’s outside assets including other 401k or 403b plans along with IRAs to create the optimal risk profile. The technology is there now but you have to ask for it.
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