Today I sat in on a webcast on “Fiduciary Best Practices in Target-Date Funds,” sponsored by Pensions & Investments. I’m going to pass on some stuff I learned.
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In December 2007, the Department of Labor added target-date funds to the list of “qualified default investment alternatives,“ or QDIA, for employers that use automatic enrollment in 401 (k) plans. Since then, these funds have mushroomed – and are expected to grow even more quickly in the future.
Matt Gnabasik, managing director of Blue Prairie Group, said that target-date funds make up 10 to 12 percent of the defined contribution market today. Over the next five years, that number is expected to grow to 60 percent of defined contribution assets.
The stock market crash in 2008 shined the spotlight on these funds because the closest target date funds at the time – the 2010s – lost an average of 25 percent. That’s hardly an acceptable return for someone who plans to retire in less than a year.
After all the criticisms and investigations, the question remaining was: Should target-date funds manage “to” the target date or “through” the target date?
Ronald Surz, president of Target Date Solutions, who has done years of research on the funds, made what I consider a cogent argument for managing “to” the date. The “to” fund assumes the investor will take the money out of the fund once he reaches the date of his retirement. So it manages the money “to” the date of retirement.
Yet most TDF vendors manage “through” the retirement date and, supposedly, to the end of the retiree’s life. There’s a good reason for that: Most vendors are mutual fund companies. For them, the target-date fund is one of the best possible ways to accumulate assets. Why should they give these assets up at retirement, just when they’ve gotten so big and juicy?
Surz argued that the most important phase of target date funds is the transition phase or risk zone. That zone lies between the time the assets grow and the withdrawal begins. His view is that the retirement money should be invested in Treasury Inflation-Protected Securities (TIPs) and treasury bills during that period. He said the biggest push-back he gets on this view is that advisors tell him those safe investments will not return enough for the investor to live on over a long life.
But Surz says that, during that transition period, the assets should be safe and the retiree should design a plan for investing assets in retirement. He says that no glide path can possibly cover the risk of that period, which is longevity risk. “Neither longevity risk nor pay replacement can be managed by a glide path,” he said. Those are not reasonable goals. “The one-size-fits-all fund takes no account of the relationship between savings and mortality.”
I think he’s right!
Surz said he expects the DOL to issue a guide to plan sponsors called the “Fiduciary Best Practice Checklist” before the end of the year.
A link to the slides from the webcast should be available on Thursday, Oct. 28, at www.targetdatesolutions.com
in the Fiduciary Corner.