Common Sense Comments for Workplace Retirement Plans
Target Date Funds are prevalent in workplace retirement plans. You’ll find them other places, but overwhelmingly they are found in things like 401(k) Plans. The idea behind them and their appeal is fairly easy to understand. People want a point-and-shoot “do it for me” option when it comes to how to invest their money for retirement.
These types of investments are easily identified by the numbers in their titles, such as “2040” or “2060”. The design of these types of investments is made to be point-and-shoot; investors simply select the year that is closest to when they think they might retire. A 55 year old, looking to retire at age 65 might then select the 2025 fund, since that’s about 10 years from now. Easy enough, right?
But how well do you know what really happens to your money after it gets into that Target Date Fund? To keep things simple, we’ll call them “TDF” for this article.
Given their popularity, the chances are good that you’ve heard the TDF pitch by now. It goes a little something like this: Your money is well diversified over a broad spectrum of investments and, as you edge toward your projected retirement year, the investments become more conservative in order to reduce big fluctuations in value (people who work in finance call this “reducing volatility”, “taking a more defensive stance”, or “selling equities and adding more fixed income”, just so you know). This means that someone is periodically deciding what investments should be in your portfolio and how much of each investment you should own.
The person or company doing that behind the scenes work for you could make all the difference. Are they looking out for you, or helping themselves? This article will arm you with some information about what to look for. First, you should know that they don’t do this for free.
TDFs are made up of a lot of different investments, typically but not necessarily all mutual funds. This is why they’re often called a “fund of funds”. This simply means that someone decides to buy or sell different funds in order to build that diverse portfolio for you. You’ve probably heard of Large Cap Funds and Small Cap Funds, for example. TDFs simply invest a little in each and then monitor your investments over time.
It helps to think of this process a little like building a team.
If you believe that selecting only the very best professionals sounds better, then you’re probably more interested in what are called “open Target Date Funds”. These TDFs work exactly the same way as those that are very limited in the managers they can select; however, they can look for the very best and most qualified professional, based on what they’re looking for. The person making the decisions about which U.S. Fund to buy, for instance, can decide to use just about any U.S. Fund professional. And if things change, and that professional doesn’t live up to expectations, they can easily switch to a different professional.
Closed Target Date Funds, as you might guess from the name, mean that the person making the decisions can only pick from one lineup of funds. This means that they cannot pick the best U.S. Fund (using the example above), they must pick only the U.S. Fund that their employer offers.
Add to this the fact that there is not likely to be any price difference between the two options and you’re likely to find most people interested in “open” TDFs. To sweeten the deal even more in favor of open Vs. closed, you should know that many open TDFs aren’t limited to just mutual funds. They can use all sorts of cost saving investments such as Exchange Traded Funds, which are similar to Index Funds but might cost less. Knowing all this, it might surprise you to know that the overwhelming majority of TDFs are “closed”.
This doesn’t mean that mutual funds are bad, or that other ways of investing produce better results, it really just has to do with whether or not you want the professional managing your money to be limited or go wherever you’re better served – this changes their focus from serving their employer to serving you.
If you’re looking for a reason why, you might not have to look any further than your retirement plan provider. Many retirement plan providers – the companies that hold your money, buy and sell investments, and create your statements and the website – also offer TDFs. In order to sell more of these and make more profit, they might offer to reduce other charges. Or they might simply put them in the plan hoping that your employer doesn’t ask for less expensive TDFs, or ones that might be more customized.
Adding to this debate, a few years ago a group of people made the claim that one of the biggest TDF companies had included funds that were not doing well and might have failed completely if not given money from their TDF manager.
Open and closed may be unfamiliar terms to you because mostly the debate has been tempered by the three main firms that hold the majority of the $800 Billion that’s been invested in such funds. All three of them are closed.
Here’s what to do with this information:
If you have TDFs in your plan, look them up on the internet and find out who manages the money. If it’s the same company that offers your plan, ask your employer if there are alternatives. You should also look up the investments that are being used. If you see that all of the investments begin with the same name, inquire about more open alternatives that aren’t as constrained. You might even find a “custom model manager”, who builds custom TDFs exclusively for your plan, often using the investments from your plan so you can more easily see what they’re doing. These custom managers are sometimes less expensive as well, because they can use less expensive investments to meet your objectives.
© Jonathan R. Broadbent and Plan Partners LLC
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Caricature of Jonathan Broadbent by David Helton