Don’t mistake activity for achievement,” Hall of Fame basketball coach John Wooden famously said, meaning just because we’re busy doesn’t mean we’re necessarily accomplishing much. Could it apply to current questions surrounding target-date funds?
Last year was undoubtedly a struggle for the retirement plan staple, Barron’s reports (citing Morningstar data).
The average TDF lost 4 percent through Dec. 10, while the S&P 500 was up just under 1 percent. And not one of 664 target-date funds on the market had a positive return.
The publication thankfully adds that they’re “designed to be long-term savings vehicles,” and it’s “the first time in a decade that target-date funds have posted widespread losses” due to a combination of factors in global markets.
Despite the hiccup TDFs are, without question, an innovation that has positively contributed to the defined contribution space, particularly in the area of participant behavior.
After stumbling out of the gate due to incorrect glidepaths and early-inception underperformance, they had the dubious honor of ending up on many financial experts’ “products to avoid” lists.
They quickly course-corrected, and drew plaudits not only for their performance overall, but also for their role in minimizing the more destructive behavior displayed by participants during market shocks (2008), which one well-known analyst attributed to their “boring structure.”
Fast-forward to 2017, when they hit the all-important $1 trillion asset mark, and remain a popular staple of 401k investment menus today.
“Use of target-date strategies in DC plans continues to grow,” Vanguard noted in its high-profile and widely-cited How America Saves 2018. “Nine in 10 plan sponsors offered target-date funds at year-end 2017, up more than 50 percent compared with year-end 2007.”
Nearly all Vanguard participants (97 percent) are in plans offering target-date funds, an important marker given the investment behemoth’s size and scope.
Consider:
- 75 percent of all participants use target-date funds.
- 66 percent of participants owning target-date funds have their entire account invested in a single target-date fund.
- 51 percent of all Vanguard participants are wholly invested in a single target-date fund, either by voluntary choice or by default.
And, of course, the qualified default investment alternative (QDIA) regulations “promulgated under the PPA continue to influence adoption of target-date funds. That said, however, voluntary choice is still important, with half of single target-date investors choosing the funds on their own, not through default.”
Strong numbers, to be sure, but debates nonetheless continue to rage about their effectiveness, use and proper deployment in the retirement portfolio overall.
Should they contain a portion, or all, of the retirement portfolio assets? If some remain invested elsewhere, does it defeat the product’s intended purpose by messing with its underlying mechanism?
More generally, and as Christine Benz, Morningstar’s director of personal finance, recently asked, do target-date funds as currently situated and constructed help solve for the issues that retirees face, or is there more work to be done?
Manufacturers have responded with products and services to meet most participant investing styles, suitability and demands, but is it enough?
Maybe not.
J.P. Morgan found that, despite reports from large TPAs of “record account balances” and “skyrocketing deferral rates,” participant problem areas persist, including not enough savings to see them successfully through retirement, spending too quickly while in retirement and the use of 401k loans in the lead-up to retirement.
Simply put, participants still aren’t positioned for retirement income success despite the best efforts of plan sponsors, their advisors and plan providers, according to the firm.
It has implications specifically for target-date design, J.P. Morgan argues, before diplomatically adding that participant behavior is “much more varied and volatile than many target-date fund providers assume, with significant ramifications around retirement outcomes.”
Anne Lester, a portfolio manager and the firm’s Global Head of Retirement Solutions, says it demonstrates the need “for plan sponsors to take into account the personal nature of retirement saving and spending in plan design.”
Noting that participant withdrawal behaviors “vary widely, from those who quickly cash out their accounts, to those who roll over their assets into other retirement accounts, and those who use them to help fund increased post-retirement spending,” plan sponsors and their advisors should incorporate the full range of these behaviors into plan design.
These include evaluating appropriate levels of equity exposure in target-date fund glidepaths.
“It’s also critical for target-date fund managers to develop asset allocation models that reflect the fact that participant assets are most vulnerable to account losses in the years leading up to retirement and immediately after.”
Undoubtedly all important and useful information, but is “fixing” target-date funds necessarily the issue, or is it simply the evergreen and ongoing matter of employee financial education (or lack thereof)?
Despite their admitted popularity, the public maintains a shockingly low level of knowledge about what they are, what they do and how they work, as AllianceBernstein recently found.
“TDFs are increasingly prevalent in DC plans, and many participants use and appreciate them,” the firm wrote in its 2018 Inside the Minds of Plan Participants survey. “But despite familiarity and appeal, TDFs are still not well understood. TDF users are now giving wrong answers more frequently than in AB’s 2015 survey—and more often than the 2018 TDF nonusers.”
Concerningly, AB reported:
- 48 percent of TDF users incorrectly believe that their TDFs automatically guarantee that they’ll meet their income needs in retirement.
- 45 percent of TDF users who believe TDFs are guaranteed say the year listed in the fund name tells them their accounts are guaranteed to be sufficiently funded in that year.
- 38 percent of TDF users think that the account balance is guaranteed to never go down.
Despite these misperceptions, TDF users “frequently state that these funds are easy to understand and make them feel comfortable that they have made a good choice.”
Which, despite the contradiction, is generally good and has participants headed in the right direction.
Ultimately, participants indicated a steady income stream in retirement was the most important goal of their plans.
“Retirement income certainty (49 percent) far outstripped the other options, such as principal protection, upside potential, downside protection and a diversified investment mix,” AB concluded. And unsurprisingly (given that many thought they already had it), plan participants reacted very positively to the idea of a TDF with a guaranteed income feature.
Ninety-four percent of all employees would keep some or all of their contributions in a target-date fund that guaranteed an income stream for life.
With more than 20 years serving financial markets, John Sullivan is the former editor-in-chief of Investment Advisor magazine and retirement editor of ThinkAdvisor.com. Sullivan is also the former editor of Boomer Market Advisor and Bank Advisor magazines, and has a background in the insurance and investment industries in addition to his journalism roots.