Retirement Meditation #14: Are target date funds the perfect solution for the employee?

Insights | Retirement Meditation #14: Are target date funds the perfect solution for the employee?

Author: Paul A. Carl, CHSA, CPFAVice President, Retirement Plan Consulting, Registered Representative

Retirement Meditation #13 focused on target date funds through an employer’s lens. This week’s Meditation redirects that focus and throws the spotlight on the employee.

As previously mentioned, target date funds are undeniably popular because of their perceived simplicity. 

A former colleague often called them the perfect “set-it and forget-it” solution for employees. “Pick a fund based on which date is closest to your retirement,” he would advise. “The fund will do the rest of the work.” 

Target date funds have an uncomplicated naming convention. “Target Date Fund 2035” is designed for employees expecting to retire on or near the year 2035. How simple is that? Except, it’s NOT that simple. 

Target date funds come in two flavors:

  • “To Retirement” Glidepaths - Generally reflect a steeper slope downward and often achieve a lower equity (and lower risk) exposure faster for participants as they near retirement.
  • “Through Retirement” Glidepaths - Normally elongated and carry higher equity (and greater risk) exposure past retirement age with a focus on life expectancy.

These two categories make it more difficult for the plan fiduciaries to evaluate similarly named funds side-by-side. A “To Retirement Target 2040” should have muted performance as compared to a “Through Retirement Target 2040” when equities are outperforming fixed income. For the participant, knowing if your target date fund is a “To” or a “Through” is important. 

For conservative investors who plan to take distribution at retirement, the participant with a “Through” target date fund should consider using the target date fund minus 5, 10 or even 15 years. Said another way, that participant who is ordinarily defaulting into the “Through Retirement Target 2040” may want to look at a fund dated as early as 2025. Of course, the opposite is true for the aggressive investor whose plan offers a “To Retirement Target Date” fund solution. The “To Retirement Target 2040” may be insufficient with a need to consider the higher risk 2050 or 2055.

In summary, informed participants should know what type of target date fund is offered and evaluate their own personal risk tolerance in order to make a fully-informed investment decision.

Do you know what you’re defaulting into?

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