Target date funds, or TDF's for short, are a popular investments for workplace retirement plans like 401k's. They give an investor the ability to diversify their retirement plan investments by allowing their fund provider to spread their assets out across multiple asset classes automatically. However, even though TDF's offer a simple way to diversify your retirement account without picking each investment on your own, studies have shown that not all TDF's are created equal and can pose risks to investors as they approach retirement. And because many plans default to using these funds, if your 401k or retirement contributions are on autopilot, you could be invested in a TDF without even having selected it yourself.
According to a letter from the House Education and Labor Committee (HELP) to the Government Accountability Office (GAO), “The employer-provided retirement system must effectively serve its participants and retirees, and we are concerned certain aspects of TDF's may be placing them at risk." In this letter, the committee asked the GAO to research several concerns surrounding TDF's.
Primary Concern #1 - Performance Variation
After the 2008-2009 financial crisis, the GAO studied TDFs and found:
A large variation in allocation between stocks and bonds closer to retirement date. Some TDFs had dropped stocks to a 35% allocation, while others remained around the 60% range.
Performance varied significantly. For example, between 2005 and 2009, annualized TDF returns for the largest funds with five years of returns ranged from +28% to -31%. However, the mean rate of return for all individual participants was 4.3%.
Different companies end up offering very different target date funds, and it becomes random about whether the target date fund in one’s 401(k) is on the conservative side or the aggressive side. This issue is highlighted after the 2008 financial crisis, where some 2010 target date funds lost more than 40% in 2008. A loss like this when you're on the doorstep of retirement can have disastrous effects.
Primary Concern #2 - Investment Offerings and Fees
In addition to varying asset allocations between TDF's, there can be a significant discrepancy between the investments that make up the TDF's and the fee structures that they charge. For example, some firms have come under heavy scrutiny for loading up their retirement plans with proprietary TDF's that underperform similar offerings from other fund managers and often carry higher fees.
In addition, a change was made during the Trump presidency that allowed TDF's to include alternative assets such as hedge funds and private equity, which often carry a risk level that is not appropriate for an investor that's approaching retirement.
Final Thoughts
TDF's are often billed as ‘set it and forget it’ investments, yet expenses and risk allocations vary considerably among funds. If you are one of the millions of families who trust their financial futures to target-date funds, you need to make sure these programs are working as advertised and providing the retirement security they promised. So if you haven't taken the time to develop your retirement plan, or are unsure what kind of investments you have in your retirement account, now is the time to do so, and we can help!. To learn more about how you can get a plan in place to protect your retirement and family's financial future, schedule a call with our team today!
AUTHOR
Mike Bink, AAMS®, CCFS®
Mike is the founder & president of Equivest Financial Advisors. He is a husband, father of 3, and a fiduciary advisor who is passionate about helping his clients take control of their retirement and reach their financial goals. Learn more about Mike.