What role can target date funds fulfill in a plan’s investment mix?

Employer-sponsored retirement savings plans are a valuable recruiting and retention tool, but they’re more than just a benefit meant to attract and retain quality workers. Your 401(k) plan can help employees build a stronger sense of long-term financial security—and if a company can help its workers alleviate even some of their financial stress, it’s all the better for everyone involved.

An employer-sponsored 401(k) plan creates a convenient vehicle for workers to save for retirement, along with potential long-term tax benefits intended to encourage employee participation.

Even with the built-in convenience of a 401(k) plan, saving for retirement requires a measure of discipline; a far-off retirement horizon can be challenging for even the most fiscally responsible employee to envision. As a result, plan sponsors often shoulder the extra burden of eliminating barriers to plan participation and improving a participant's likelihood of growing their retirement savings.

That’s where target date funds (TDFs) come in. TDFs can add another degree of simplicity and convenience for plan participants, which in many cases may help more investors get closer to their long-term retirement savings goals.

But like any investment, TDFs have their upsides and downsides and in some cases, well-intentioned plan participants can make investment decisions that could derail a TDF’s intended investment diversification strategy.

So, how do TDFs fit within a plan menu, and how can plan sponsors help participants make informed choices about whether to invest in them?

The big idea behind TDFs: overcome participation barriers by simplifying investing

TDFs provide a diversified, ready mix of investments based on an investor’s estimated target retirement date and age. Simply put, a TDF is a “fund of funds”—a portfolio that’s periodically rebalanced by the fund manager. Over time, the TDF’s asset allocations move from a more aggressive mix of stocks, bonds and other investments to a more conservative mix, often including more cash and bonds, as the participant’s estimated retirement date nears. This shift is known as the TDF’s glide path.

A TDF is intended as a long-term investment strategy with one-stop-shop simplicity. For the investor with little investment knowledge or time to dedicate to researching and choosing allocations from a plan menu, a TDF may be an effective tool for eliminating barriers and encouraging investing. A participant can simply select the TDF that corresponds most closely with their expected retirement date and age at retirement. Diversification and rebalancing are left to the professionals who manage the funds.

TDFs are a common QDIA selection

Because target date funds are professionally managed and built to balance appropriate risk exposure with growth potential based on investors’ estimated retirement dates, they’re a popular choice for a plan’s qualified default investment alternative, or QDIA. A QDIA is a plan’s default investment vehicle. For plans that include auto-enrollment, for example, contributions are automatically invested in the QDIA unless or until the plan participant elects a different allocation from the plan menu.

In this way, TDFs can be part of a plan’s toolkit for encouraging employee participation while also meeting fiduciary obligations—assuming plan fiduciaries regularly review TDFs to assess their fit for current plan participants. Plan fiduciaries should review plan performance and fees as well as investment strategies and glide paths. It’s also important to keep in mind that age, along with retirement date estimates, plays a role in how well a fund fits a participant. 

For example, two employees may retire the same year, one at 60 and the other at age 70. That 10-year age difference is likely to have an impact on their retirement investment strategy needs. Consulting with a plan provider can help a sponsor choose from among several off-the-shelf TDF options—or whether to develop custom funds to more closely align with their employee demographics.

TDFs don’t replace communication and investment education

As effective as a TDF can be at simplifying investment decision-making, it’s still important for plan participants to understand:

• what a TDF is
• how TDFs are designed to meet diversification objectives
• fees and expenses associated with the fund
• how a TDF shifts from aggressive to conservative investments over time
• how closely aligned a TDF is with their estimated retirement date and age
• that TDFs, like other investments, are not guaranteed, and participants may lose money

Participants who don’t understand the already diversified nature of a TDF they’re invested in could make allocations that affect their overall growth potential and risk exposure—essentially working against the TDF’s investment strategy (and their own long-term retirement interests). For example, as the TDF moves funds toward cash and bonds, a participant who moves savings into stocks could be taking on greater risk.

Along with careful evaluation and selection of TDFs to meet plan participant demographics and retirement goals, sponsors can do more to help employees understand the way TDFs work and their place in the plan. Reaching out to plan participants with educational materials, presentations or other communications is a smart place to start.  Reach out to learn more about the ways Cuna Mutual Group can help you and your plan participants achieve a secure financial future.

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