Read the Label Prior to Purchase

Target Date Funds

The market volatility introduced by the coronavirus outbreak has certainly tested the nerves of investors. Sponsors of employer-based retirement plans spend a great deal of time worrying about the reactions of their employees to such downturns. Their greatest fears are that plan participants will panic during a stock market drop and subsequently sell all of their holdings to lock in substantial losses. They will then become very risk averse in the future and avoid repurchasing equities until the lion’s share of the recovery has already taken place. Even professional investors fall victim to these tendencies so plan sponsors reason that surely unsophisticated employee/investors will do so as well.  The end result is an inadequate retirement account balance and blame being thrust on the plan sponsor/employer.

Target date funds (TDF’s) were designed with these novice investors in mind. Generally, the employer will include a series of professionally managed, pre-arranged portfolios with varying degrees of stock market exposure. The employee merely needs to decide how aggressive they would like to be and then funnels all of their contribution dollars into the designated target date fund.  The professional manager stays invested through all market cycles according to the fund’s mandate and reduces equity exposure as the target date for retirement nears. Sounds simple and easy, doesn’t it?

Since these target date funds require a minimum of participant effort and intervention, they have become very popular. Often,  they are designated as a default investment when the employee fails to make a definitive choice upon plan enrollment. Some estimates suggest that more than 80% of new plan deferrals go into TDF’s. The problems arise because employees never took the time to learn anything about their target date fund.

According to Employee Benefit Advisor magazine (May/June 2020), 84% of participants say they don’t understand target date funds. Fully 64% of participants believe that TDF’s carry some level of guarantee.  Despite the fact that surveys have established that millennials are the second most risk averse generation (after only Depression era babies), many are invested in TDF’s having as much as 90% equity exposure.  This is because the designers of the TDF have logically reasoned that all millennials have many years to invest until retirement and can “ride out” market turbulence.   However, this runs contrary to their professed aversion to risk

All of this can be avoided by simply reading the label prior to purchasing…..