Our Target Date Fund (TDF) selection process incorporates three decision tree matrices designed to identify the TDF goal. There are presently about 45 target date fund series across almost as many mutual fund families. Since no two professional investment organizations will agree on the best asset mix for any given participant age, each TDF family may have highly divergent risk mixes compared to other TDF fund families. The risk/return ramifications to your participants can be profound. For example:
- Concerning age-30 participants, some TDF series will be as much as 95% invested in stocks, while other series as little as 75% invested in stocks.
- For age-60 participants, some TDF series may be invested 70% in stocks, while other TDF series may have as little as 40% invested in stocks. If an extended bear market (or bull market) happens near retirement for the age-60 group, the impact on the lives of your co-workers arising from the plan’s TDF selection decision can be momentous.
- Some TDF families will use as few as four or five funds within the compositional makeup of a TDF series. Others may use 20-25 mutual funds to create their target date series.
- A few TDF series use all index funds in order to achieve very low cost, while others will use primarily active management (at considerably higher cost) in attempt to outperform markets. Most don’t.
- Some TDF series actively manage the target date funds asset mix throughout a participant’s retirement years.
- Other TDF series adjust the participant’s risk mix only “to” the point of retirement, usually age 65, and then stop making asset mix adjustments thereafter.
- Some employers have a participant population that is heavily weighted to the younger end (or the near-retirement end) of the spectrum, causing the optimal asset mix construction to point more clearly to one TDF family versus another.
- One employer will maintain a defined benefit (pension) plan arrangement along with a “supplemental” 401(k), 457 or 403(b) plan. The safety net of the defined benefit plan may argue for the ability to select more aggressiveness for the target date fund series.
- But more frequently the opposite is true: The 401(k)/457/403(b) plan is the participant’s only retirement vehicle and, just as likely, those participants may have relatively low balances, causing the plan sponsor to again select a more aggressive TDF series.
Asking the obvious, why not just pick the best-performing target date fund series and be done with it? To answer with a question, did the performance evaluation periods in question occur during a bull market or a bear market? Bull market evaluations will bias “best performing” TDF selection to the most aggressive asset mixes, just as bear market evaluations will bias the “best performing” conclusion to TDFs with more conservative glide paths.
Tips for ERISA Plan Fiduciaries
To assist plan fiduciaries in selecting and monitoring TDFs, in February, 2013, the U.S. Department of Labor issued target date fund selection guidelines in a publication titled, “Target Date Retirement Funds - Tips for ERISA Plan Fiduciaries”, available at this link.
We think it boils down to this: by examining three categories - Plan Objectives, Plan Demographics and Participant Behavior – the asset mix “fit” of your TDF selection can be matched to your plan in an objective, and well documented process. With asset mix decided the plan can then focus on other selection attributes like performance and low cost.