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.

Why TDF?

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?

Selecting a target date fund for a plan is a matter of understanding what affects the participant experience at the end -- at the target date. The two key factors are:

The objective: The objective is determined by asking whether the plan’s TDF option should: continue to take on risk even as retirement approaches in order to maximize every investment dollar? Give up some future growth by switching into highly conservative asset classes in the run-up to retirement? Find a middle ground and support a predictable and sustainable drawdown of principal in retirement?

The shape of the glidepath: The glidepath describes the fund’s asset allocation from inception through the target date. Generally speaking, the fund will have more equities at the beginning and more fixed-income investment at the end. Important considerations include how quickly the risk level slopes down as the target date approaches and whether it continues to roll down after the target date.

Views on these questions have evolved over the years. For example, increasing longevity and the tendency of participants to remain in the fund after retirement drove our decision several years ago to increase our equity position at the target date from 20 percent to 38 percent. We believe that a higher equity allocation and the inclusion of real assets and TIPS lead to a more sustainable drawdown in retirement.

Other objectives and glidepaths serve different visions. For an advisor, the key to success is matching sponsor goals and participant needs against the fund’s specific features.

The Future Of TDF

Twenty years into the target-date era, TDFs appear to be a secure feature of the retirement landscape. What’s more, participants see the value: 89 percent of participants like having a fund that rebalances over time (TDFs' key feature), according to our latest BlackRock Retirement Survey. Yet only one in four participants are actually invested in a TDF -- and about three in 10 said they are not sure if their employer even offers one.

Clearly there is more work to be done in delivering TDFs' potential benefits to participants.

I believe TDFs are viable for the future and, when combined with intelligent plan designs to encourage savings, they can create successful retirement outcomes for most participants. Advisors unquestionably can play a leading role in helping DC sponsors provide solutions that truly support participants along their entire path to retirement.

Chip Castille is managing director, head of BlackRock’s U.S. & Canada Defined Contribution (DC) Group.