Why Alternative Investments in 401(k) Target Date Funds Make So Much Sense

401k, alternatives, retirement, target date funds
Non-correlation is key.

A report we somehow missed in June from the Georgetown University Center for Retirement Initiatives (CRI) highlights how target-date funds can be modified to possibly improve expected retirement income for individuals.

The report shows that the strategic use of alternate assets in a TDF can increase retirement income and lower risk.

The report, entitled “The Evolution of Target Date Funds: Using Alternatives to Improve Retirement Plan Incomes,” finds that the underlying asset classes in TDFs can be broadened to include alternative investment strategies such as private equity, real estate and hedge funds to create a “diversified TDF.”

“These diversifying asset classes are common in defined benefit pension programs,” the report notes. “Given the trend of sponsors offering less DB benefits to employees, utilizing these strategies in a TDF can help the performance of DC plans by improving returns when compared with a portfolio of equities and fixed income.”

“Our analysis showed that a diversified TDF could increase the amount of an annual retirement income that can be generated by converting a participant’s defined contribution balance into a stream of income at retirement by between 11 and 17 percent depending on market conditions,” Angela Antonelli, the Center’s executive director, said in a statement.

Increasing diversification in TDFs will require education and oversight. Issues such as liquidity, pricing, benchmarking, fees and governance need to be considered.

At the same time, given the low savings rates of the majority of workers, there is some urgency to develop new ways to improve retirement outcomes for these employees through holistic planning, including investments, plan design and communication.

A diversified TDF has a higher probability of maintaining positive retirement assets after 30 years of retirement spending. It also provides higher expected returns and lower downside risk at the time of retirement, and 10 years post-retirement. This mitigates the negative impact of a short-term market shock for those participants at or near retirement, according to the report.

“Policymakers should consider these findings about the inclusion of alternate asset classes in DC plans, specifically through target date structures,” Antonelli concluded. “Even absent any additional action by policymakers, plan sponsors with an interest in implementing portfolios with alternate asset classes can work with their advisors, custodians and recordkeepers to implement solutions that enhance participant outcomes for a more secure retirement.”

John Sullivan

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.

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