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Retirement Plan Administration: The Problem with Target Date Funds

By almost any measure, target date funds have been a runaway success.  These funds, in theory, provide a fantastic service:  you pick a fund that matches when you expect to retire, and the fund takes care of all the details for you, like asset allocation and rebalancing.  These funds are perceived by many as a simple and ideal solution in the complex investment world.  If you’re not comfortable investing for your future, simply pick a target date fund with a date near when you think you’ll retire.   Presto…you’re done!

The statistics show just how well this idea has been received by retirement savers.  A recent report by The Vanguard Group found that an estimated 51% of retirement plan participants used a target date fund as their sole investment.

And retirement plans have embraced target date funds as well.  According to that same report, an estimated 97% of plans with automatic enrollment adopted target date funds as the default investment option.

Target date funds are an easy sell because they are easy to understand.  And the sales pitch is a good one:  Pick your retirement date and all the asset allocation and timing is taken care of for you.

Unfortunately, as with any investment, there is no one magic solution.  While target date funds provide convenience and simplicity, they have some serious potential issues too.  If you’re a plan sponsor, you’re a fiduciary for the plan, so these factors should be considered and weighed prior to adopting a target date fund as the default investment option.

High Fees.  Target date funds are considered actively managed funds and so they generally carry higher fees than passively-managed index funds.  According to the Investment News, the average expense ratio for target date funds was 0.66%.  However, target date funds vary with investment practices.  Investors probably assume that target date funds are doing a lot of work for them, but in reality, some of these funds are not very actively managed.  For example some target date funds buy index funds and then rebalance only every five years.  That’s not a lot of work for that high of a fee.

Fortunately, target date expense ratios have been trending down, but investors still are paying a high premium for something that may not be as dynamic as they may perceive.  And that fee premium alone may put a dent in their returns versus lower fee options.

No Long-Term Track Record.  Target date funds are relatively new so there isn’t much long term performance data yet.  No one really knows how these will perform over the very long term.

In fact, most target date funds did not perform well during the Global Financial Crisis of 2008.   Fortunately, most of these funds have recovered, but the fact remains that there is no long term track record.

Given that fees are a lightning rod for litigation these days, plan sponsors want to be very careful about selecting target date funds for their lineup. If you’re going to go that route, be sure to pick a target date fund with reasonable fees.  Or, look for lower price options that can provide similar results for a lower fee.

The Danger of Simplicity.  Another issue with target date funds is their simplistic, one-size-fits-all approach.  Let’s say you have three employees who plan to retire in 2030.  They do have an ideal retirement date in common.  But the similarities might stop there:

  • One is a single parent with a child in college and a mother who is starting to need financial help.
  • One is the spouse of a high earning physician.
  • One is a young worker aiming to retire in her 40s.

In this example, all of these people have radically different life situations.  The target date fund will likely work for one or maybe two of them, but hopefully the others will have received more personalized financial planning to help them prepare appropriately.  Our society’s increasing longevity throws another wrench into this situation.  As a retirement plan advisor, seeing all these different people pile into target date funds is a source of concern.

Proceed with Caution

While target date funds are one option, plan sponsors must always keep their fiduciary responsibility in mind.  Therefore, keep your eyes wide open when evaluating target date funds for use in your plans.


John Odell is Principal of Capital Research + Consulting, a Retirement Plan Advisor to governmental, non-profit and corporate retirement plans.   With over $4 billion in plan assets, we have over 27 years of experience keeping plan sponsors compliant and helping participants prepare for the future.  Visit us at www.capitalresearchandconsulting.com.

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