THE TARGET DATE FUND STORY is supposedly elegant and simple—select the date around when the participant plans to retire and the fund will take care of everything. As the retirement date approaches, the TDF will rebalance to a more conservative mix, and manage that mix not only into retirement, but throughout it as well. The TDF is a “one stop shop” where the participant can “set it and forget it.”
If only it were that simple.
The TDF has proven to be no silver bullet for plan participants. While the TDF may have made the investment decision easier, it did not necessarily make the retirement outcome better. It’s true that TDFs are likely better than having participants attempt to build their own asset allocation, but, is it really that difficult? Simply ask a participant to explain the difference between stocks and bonds. If this leads back to the TDF, what next? If the TDF isn’t the answer, what is? How can participants make a better investment decision when the very solution touted to do so fails in its endeavor?
It may help by first understanding the TDF’s flaw, which is the assumptions it must make. Every TDF makes assumptions about risk, future returns and funding levels. Among all of the assumptions lies the most important assumption of all—the savings rate. As the saying goes, “10 percent of nothing is nothing.” While investment assumptions are important to the investment mix and the optimal target date fund, the participant savings rate and the degree to which they are funding their retirement is critical. The highest earning TDF will never get participants to where they want to be if they haven’t saved enough in the first place.
Which leads to the most important point—target date providers make different assumptions about participant savings rates. Assumptions are made based on and for the average participant. Even then, assumptions vary greatly. Those most disadvantaged by the “averages” assumption are the participants not saving enough, as well as participants purportedly doing well for themselves by saving more than enough. These two groups are severely underrepresented when using averages. The industry, in general, thinks participants don’t save enough.
Acknowledging this, how do we make the investment decision better for participants if it’s not TDFs? Surely participants can’t do this themselves, or can they?
Yes, they can. When the savings rate and funding for retirement plays such an integral role in retirement, it is easier than you think. Defined benefit plans call this “liability driven investing” (LDI). The concept simply refers to the amount participant saved (funded status) and its integral role in asset allocation. For participants on track to save enough, their asset allocation should be more conservative than participants who are barely funding their plan. Late savers need to take more risk in their portfolio if they hope to retire as successfully as the participant who has saved enough.
Nick Della Vedova is president of flexPATH Strategies and Retirement Plan Advisory Group in California. For 25 years, Nick has worked closely with plan sponsors, service providers, advisors, money managers, trust companies, and broker-dealers to help bring positive changes to the retirement planning industry.
