$823 billion dollars of assets currently reside in Target Date Funds as of June 30, 2016, according to Morningstar Research. ¹ Also, forty cents of every new dollar going into DC plans is invested in target-date funds, according to Robert Austin, Charlotte, N.C.-based director of retirement research for Aon Hewitt. ² Most 401(k) and 403(b) plan sponsors monitor and evaluate investments in their plan using a prudent fiduciary standard that is applied to every investment in their offered investment menu to plan participants. But is this correct? Due to the level of inflows into Target Date Funds and their unique investment characteristics, many more layers of additional consideration and scrutiny is warranted. Our firm, when talking to decision makers for retirement plans, find many plan sponsors making the following rookie mistakes when they evaluate their 401(k) & 403(b) target date funds:
1. Grading Each Fund in a Target Date Fund Series individually, instead of looking at the entire series.
Plan sponsors have been trained for decades by retirement plan advisors to evaluate each individual investment option presented to participants on their own merits. When plan sponsors try to pick the best of breed in each vintage year of a target date fund, they inadvertently cause a large problem for 401(k) and 403(b) plan participants. Choosing differing fund vintages from multiple series leads to confusion as there would be many de-risking glide paths to consider. To avoid this error, one series of a target date fund should be selected for your plan as each vintage fund in the series will be following the exact path of de-risking assets through a participant's career and retirement.
2. Failing to account for how the glide path of the Target Date Fund series matches (or doesn't) your participants behaviors and demographics.
How prepared is your participant base for retirement? Are they blue collar or white collar workers? What's the average savings rate of the group? Do most participants withdraw the entirety of their funds at retirement? What is the average participant's attitude towards risk? These questions and more are great to answer as they will help decide the retirement plan's committee decisions about whether to choose a "To" retirement date path versus "Through", and other key components of the funds.
A common trap that many plan sponsors and advisors fall into starts with treating all investment options in a retirement plan the same. However, target date fund investments are meant to be a dynamically shifting asset allocation fund that changes with behaviors of your participant base. Screening on pure investment results, expense, or other standard metrics may not be capturing underlying dynamics of the series for your participant base. The Wagner Law Group has a nice powerpoint summary to help sponsors analyze some of these points.
3. Picking your record keeper's, custodian's, or another interested party's Target Date Fund series because they're willing to discount their services if their own target date fund series is chosen as the default investment.
Revenue sharing provided by Target Date Funds should be considered in the overall scope of all fees charged to the plan, especially if the participants are bearing the costs of the plan. This is a big topic of class action lawsuits against plan sponsors that use revenue sharing from funds to pay for vendor services, such as a case seen here. Understanding all the costs of a retirement plan is very difficult as fees can be assessed as explicit costs to the company or deducted from participant accounts. Or in many cases, revenue sharing offsets from plan investments can assist in partially or totally covering all costs in the plan. The plan sponsor and retirement plan committee has a fiduciary obligation to understand the fees, and how they compare against other like sized retirement plans. A red flag should always be present in a plan fiduciary's mind when they hear from a proposed vendor the retirement plan is free, or has zero costs. Retirement plans are not free in cost to operate as multiple parties are performing significant labor in investment advisory, record-keeping, third-party administration, custody, and trust solutions to provide this great benefit to company employees.
Make sense? We hope these three points help a plan sponsor evaluate Target Date Funds suites and provide you with an understanding of how our firm works with retirement plans to improve their thought process and governance of these funds. If you want to read more on this topic and work to improve some of these items yourself, feel free to download our free Navigating the Target Date Fund Evaluation ebook from the button below.