Ensure Your Target Date Retirement Fund Does What You’re Expecting

Back in those early days, participants in 401(k) plans were satisfied to invest their contributions in relatively safe fixed-income investment vehicles.  As the landscape changed, and 401(k) plans assumed a more primary role in retirement income, demands for investment options within these plans changed.

Fueled by dramatic increases in stock prices during the second half of the 1990s, participants sought out increasingly more stock investments with little regard to inherent risks of these markets.

During that same period (mid-1990s), mutual fund companies started to introduce target date funds, designed to shift the responsibility of investment decisions and asset allocation from participants to a professionally managed portfolio.

These funds followed an increasingly more conservative asset allocation (often referred to as a glide path) as retirement approached. In those early years, while equity markets were still expanding rapidly, target date funds got little attention from participants intent on riding the stock market wave that would seemingly never end.

Not until after the tech bubble burst and equities gave back their gains from 2000 to 2002 did participants realize that risk management was a key element in building an investment portfolio. Indeed, target date fund assets in 401(k) plans rose dramatically from roughly $15 billion at the end of 2002 to over $179 billion by the end of 2007. Finally, participants decided to turn their retirement nest eggs over to professional managers in time for the next market collapse at the end of 2008.

Then, a not-so-funny-thing happened during the market collapse of 2008-2009. Target date funds seemed to lose as much money as any other type of fund. We would expect those with target dates far into the future, and therefore presumably with much higher stock allocations, to suffer significant losses during the decline. But those with a closer target date would be more protective, right? Not necessarily! In fact, according to the SEC, 2010 target date funds lost an average of 24 percent in 2008 and ranged from losses as little as 9 percent to as high as 41 percent.

So, what did we learn about target date funds?

1) Not all target date funds are created equal. Vast differences exist in the equity/fixed income ratio among fund companies that manage target date funds. Expenses also vary dramatically among funds from different companies.

2) A disconnection exists between what investors buy and what fund companies deliver. Many investors expect their target date funds to reduce equity exposure significantly as the target date approaches. However, many fund companies operate these funds as if participants will continue to hold them as their primary investment vehicle throughout retirement, allowing for a larger equity allocation. Neither expectation is necessarily inappropriate, they are simply mismatched.

3) Target date fund evaluation is difficult. Some funds have been around since the mid-1990s. Many others are still being developed by fund companies that want a part of this market share. Since history is variable, an evaluation of performance alone is not going to work. Expenses, glide path, portfolio construction and the fund family’s historic orientation toward its shareholders are very important. After all, the goal is for the participant to own this fund at least until retirement if not beyond.

During the last 30 years I have conducted more employee education meetings than I can count. Despite great PowerPoint presentations, multi-colored education workbooks and illuminating graphs and charts, at the end of every meeting, many participants simply want to be told what to do. That will probably not change as investments become more complex throughout the years.

Participants want a solution they can implement simply. Target date funds have become the most common solution, but they are not the only option. Target risk or lifestyle funds that provide four or five separate and distinct portfolios with distinct equity/fixed income allocations are often a better alternative. Utilizing target risk funds along with an evaluation of an individual’s risk tolerance allows us to match a portfolio and risk profile most effectively. Tune in for my next article on the pros and cons of both approaches.

Lee Kliebert is managing partner and chief investment officer for PensionTrend Investment Advisers, LLC, headquartered in Okemos. PTIA provides investment advisory services in a fiduciary capacity to more than 200 qualified retirement plans.








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