Help Participants Avoid These TDF Missteps

Target date funds are in high demand these days. According to a recent Sway Research study, total TDF assets reached $3.5 trillion in 2023 — a record level. Moreover, mutual fund target dates began 2024 slightly ahead of collective investment trusts, holding $1.76 trillion in assets compared to $1.71 trillion in CITs, TDF assets in CITs are expected to overtake assets in mutual funds this year as fiduciaries continue to look for ways to reduce fees and access innovative solutions.

TDFs offer participants many advantages: a simplified investment decision-making process, diversification by professional fund managers, automatic rebalancing, a glide path strategy that adjusts risk over time, and much more. Given the popularity of these funds, plan sponsors should help ensure participants understand how their TDF works to maximize their potential benefits — and avoid common missteps that can undermine their retirement strategy.

Getting mixed up. TDFs are designed as stand-alone investments. However, some participants may not realize the potential impact of mixing their already diversified funds with other investments, including inadvertently increasing their risk exposure. Understanding the underlying strategy behind TDFs is crucial to maximizing their utility as part of a prudent investment plan and avoiding any unintended consequences. TDFs typically do not transparently indicate their risk level so participants may find it difficult to easily determine if the plan’s selected TDF is a good fit for them.

Some things change. TDFs are often thought of as a set-it-and-forget-it investment, but retirement time horizons, individual investing goals, or risk tolerance may change over time. Without regular reviews with a financial advisor, the TDF and participant may end up on divergent trajectories.

Hype hunting. Participants looking to capitalize on the latest hot market mover, such as AI, may feel they’re missing out on their TDF due to a lack of control over individual investment choices. For these types of investors, the selection of a TDF may be based more on its popularity than a full understanding of its operational parameters — and the potential benefits of a well-diversified portfolio. This is partly because, in the short term, diversified investments don’t always feel gratifying. In a bull market, for example, they’ll typically underperform the S&P 500; and in a bear market, they usually outperform the S&P but may still yield negative absolute returns. Employees should be educated on the benefits of diversification that have been historically born out with solid performance and overall risk reduction when participants maintain a long-term time horizon for their investments.

When paths cross. Not all TDF glide paths are created equal. For example, some allocate more heavily to equities resulting in a more aggressive growth-oriented glidepath while others prioritize stability via a higher allocation to fixed income. Investors should also understand how their assets are managed during the accumulation and decumulation phases.

Targeting Knowledge Gaps

With the tremendous growth and popularity of TDFs, participant education on the topic can be an important and valuable addition to financial wellness programming. By empowering participants with knowledge and guidance, plan sponsors can help them navigate the complexities and nuances of TDFs to make better-informed decisions about their retirement strategy.

Sources

https://static1.squarespace.com/static/5661aba4e4b0c3b0ea70a07a/t/65c4eec9862cb467557d1102/1707405005580/Sway_Res_2024_StateofTDs_Brochure.pdf

https://www.morningstar.com/funds/are-you-using-your-target-date-fund-incorrectly

https://www.plansponsor.com/target-date-assets-reach-record-high-3-5-trillion-in-2023