Twenty years ago, the target-date fund (TDF) couldn’t have been simpler; there was only one fund.
That’s not the case today. TDFs capture 74 percent of cash flows into defined-contribution plans and are available on up to 80 percent of all plans. Once you include customized options, dozens of TDF options are available. Plan sponsors have multiple target paths to choose from on behalf of participants. But how to determine the best one? Therein lies the consulting opportunity for the DC-focused advisor.
When the first TDF was launched in 1993 (an effort in which I participated), the motivation was, in part, to reduce what we saw as unnecessary complexity.
At the time, DC plans focused on providing choice. Some plans offered as many as 100 or more funds, a bewildering array of choices that few participants had the time, expertise or, frankly, interest to decipher. Experience showed that when they did pick funds, the things they chose were often inappropriate or insufficiently diversified, and they were not being monitored or adjusted over time.
Simplifying participants' choices made sense from a fiduciary point of view. The TDF breakthrough was the recognition that the time until retirement -- whether the participant was five or 40 years out -- was the single most important factor in shaping an outcome. Using time to retirement to drive asset allocation across decades of a working career, the TDF became an elegant, single vehicle for managing a whole complex range of investment decisions.
Issues For Sponsors And Advisors
Why are there so many different target-date funds today and what are the differences among them? In large measure, the differences result from sponsors’ need to make a choice regarding precisely what they want for participants when they retire.
For example, in evaluating funds with a target date of 2055, you and your client would need to consider:
• What will the participant need at 2055: growth, preservation, stability?
• How will they behave? Will they roll out of their plan or expect to withdraw income from the fund for decades?
• How rapidly or slowly should the portfolio taper off risk as 2055 approaches?