What’s Next for 401(k) Target Date Fund Innovation?

401k, retirement, target date funds

What's worked, and what still needs to happen?

“It’s always been the great thing about target date funds,” explained Joe Martel. “You’re able to deliver that institutional design and expertise, where the complexity is masked by the simplicity of choice for participants.”

Martel, a vice president and member of the target date solutions investment team at T. Rowe Price, had plenty to say about the product, specifically about the active-passive management debate, target date funds’ role in positive participant outcomes and what still needs to happen to make the product more effective.

“From our perspective, we’ve seen almost constant innovation and evolution,” he began, “whether it be diversification within equities or fixed income. Fixed income is one that we’re particularly conscious of, given enhancements we’ve been making to our fixed income portfolio. And we’ll continue to try to deliver a level of sophistication within a target date that you see in other institutional asset pools.”

That evolution of the underlying diversification is ongoing, he added, as asset managers continue to think about more institutional-like approaches delivered through a target date format.

Controversy continues over whether target date funds have “proven” themselves from a participant outcome standpoint. While there’s widespread agreement—and some evidence—that target date participants behave better in volatile markets, are they better about providing an affordable quality of life in retirement for investors?

“Two things,” Martel responded. “One is that, to your point, there is some proof already that they have generally improved asset allocation and outcomes for participants. You tended to see what we would call ‘extreme’ asset allocation from non-target date users, where they had too much in cash for a young investor and too much in equities for an older investor.”

Secondly, he said, when analyzing pure performance, target date investors outperform those who have picked their own investments.

“When we look at the investors on our recordkeeping platform that do not use a target date, only about 30 percent do better than they would if they were in an age-appropriate target date fund. But ultimately, I think we’ll have to wait a few years—until the first set of participants who used target dates their entire career—begin to retire to judge how well they’ve accomplished their goal.”

Martel rightly emphasized, however, that target date investment (or rather accumulation) is only one part of the equation—they have to be saving and deferring enough as well.

“The best-designed TDF will do no good if participants aren’t saving enough,” he pointedly stated.

Sensing Martel isn’t one to shy away from controversy, we asked for his target-date take on the evergreen and ongoing active/passive debate, and specifically, if there is any such thing as a passive investment within a target date fund.

Even if the fund claims a passive strategy, the underlying assets must still be closely monitored to ensure objectives are met, naysayers contend, to which he agreed.

“We would say there isn’t really a purely passive target date fund, in the sense that the glide path and other strategic asset allocation decisions are active decisions. They’re based on judgments and input. There’s obviously passive implementation of target date funds, but the underlying building blocks can’t be passively managed. If passive is viewed as lacking any kind of active decision-making in the investment process, then there truly isn’t a passive target date strategy.”

So, what specifically should plan sponsors be thinking about when choosing target date funds or evaluating an existing target date menu?

First and foremost, he said, they should ensure the target date solution aligns with their plan objectives.

“We are big believers in the fact that the objective or goal for the plan as it relates to income replacement in retirement (relative to moderating volatility) should really influence the target date fund and glide path that is appropriate.”

Retirement income is, of course, a major theme, and the decumulation side of the equation is something Martel sees on the horizon.

Noting that target date funds, by themselves, could be used as a reasonably good decumulation tool, “the big challenge is the participant experience, in terms of developing a strategy that is right for their particular situation. It’s a much more individualized decision then accumulation. We’ve been researching that side of the equation for some time. We continue to more formally hire research resources to help analyze how individuals spend in retirement and how those different consumption patterns impact income solutions embedded in (or working side-by-side with) a target date strategy.”

Martel claimed that T. Rowe Price has always had unique insight into the behavioral component of the glide path, one reason for the firm’s success in the space.

“We’ve been a provider of retirement plan services since the late 1970s and early 1980s. Having that insight into how preferences and participant behavior influence glide path design, and having that intuition early on, was an advantage for us. We were the first ones to recognize the problem we’re solving for does not end at retirement, and that time in retirement should be a part of the asset allocation equation is what’s differentiated us.”

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