The meteoric growth of 401k automatic enrollment has been accompanied by equally impressive growth in the use of target date funds (TDF) as the default investment option for 401k participants who don’t want to be heavily involved with investment decisions. 1
TDF’s “Target Date Funds” are investment funds that invest in a mix of assets, and shift from higher-risk to lower-risk investments as a participant approaches their “target” retirement date. TDF can benefit 401k investors in several ways:
- By automating investment decisions, they relieve DC plan participants of the burden of deciding how to allocate their retirement savings among equities, fixed income, and other investments.
- Provide professionally developed asset allocation based on their planned retirement date.
- Can help 401k participants avoid common investment pitfalls, such as a lack of diversification and a failure to periodically rebalance their assets.
But despite their many benefits, a new Government Accountability Office (GAO) report on target date funds finds that TDF’s have some problems that need to be addressed:
- TDF’s are intended to simplify investment decision-making for 401k participants uncomfortable with the nuances of investing. But TDF’s can still be quite risky. Indeed, the GAO report was spurred because some TDFs designed for those expecting to retire in 2010 experienced major losses during the financial market downturn of 2008-2009, placing the retirement security of many participants in jeopardy. In one case, a TDF designed for participants retiring in 2010 lost over 40 percent of it value. Bottomline: 401k participants contributing to TDFs still bear the full burden of investment risk.
- TDF’s with seemingly comparable target dates and investment objectives can vary widely in terms of investment allocations, risk profile, and performance. For example, GAO found that among 5 TDF funds it reviewed with similar target dates, equity (or stock) investments at the target date ranged from 33 percent to 65 percent (see graph).
- Similarly, retirement and investment philosophies of TDF fund managers have wide variances, even for TDF’s with comparable targets. Some TDF’s focus on arriving at the target date without major losses while other TDF’s goal is to assure that assets are not depleted throughout a retirement that may extend 30 years beyond the target date. Whether a TDF focuses on getting you to retirement or through retirement is an essential factor to understand.
TDF’s are definitely here to stay. Their growing popularity and appeal for 401k participants seeking to simplify retirement planning and investing is unquestioned. But these benefits should not come at the expense of complacency. The GAO calls for greater transparency, participant education and disclosure regarding TDF assumptions be provided.