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Target date funds are popular options, particular in employer-sponsored retirement plans, because they do some heavy lifting for end users, particularly those that want the benefit of financial market participation without having to tend to portfolios on a daily basis.
Additionally, target date funds typically offer a mix of equities and fixed income, favorable fees and many of these products are issued by familiar, large fund sponsors, presenting investors with some level of comfort.
“Target-date funds (TDFs) typically reduce downside risk by lowering exposure to equities under normal conditions. But recent turbulence has demonstrated that a selective use of defensive equities can help reduce volatility through especially challenging market conditions,” according to Alliance Bernstein.
Even with the benefits offered by target date funds some homework is required because there are multiple issues to consider.
Starting Points for Target Date Evaluation
Good news for advisors and clients alike is that fund fees, including those on target funds, are declining, meaning investors keep more of what they earn.
“The average expense ratio paid by fund investors has been falling for two decades. In 2021, the asset-weighted average expense ratio across all mutual funds and exchange-traded funds (not including money market funds and funds of funds) was 0.40%,” notes Morningstar analyst Bryan Armour. “This is less than half of what investors paid in fund fees, on average, in 2001.”
However, as Fidelity points out, there’s more to the target date fund evaluation process than merely focusing on costs.
“While this universe of investment strategies is generally associated with low fees and a perception of fiduciary safety, these portfolios have meaningfully different risk and return profiles, driven by varied product objectives and designs,” notes the fund issuer. “For instance, equity exposure in this group of funds, intended for investors planning to retire in or around 2025, ranges from 46% to 56%. These differences suggest that a more comprehensive evaluation of each target date option is warranted.”
Another element in target date funds, and it’s one likely overlooked by many participants, is the end user’s own behavior. Put simply, the earlier the participant begins saving, the more they strive to max out contributions and the longer they delay retirement, the more likely they are to wring significant benefits from the target date strategy.
“While participant behaviors have improved over the years through programs such as auto-enrollment and the use of qualified default investment alternatives (including target date strategies), most participants still fall short of optimal savings rates,” adds Fidelity.
That says advisors can help clients focus and stay on the right track, even with employer sponsored-plans.
Other Avenues for Advisors to Shine
As noted above, many clients embrace target date funds due to the instruments’ simplicity and set-it-and-forget nature. However, advisors can still equip clients with questions to ask regarding target date offerings.
Those include pondering whether the fund provider is aligned with the retirement plan’s broader goals and evaluating the manger’s investment process.
“As is the case with any investment option, careful evaluation of target date strategies should continue even after an initial selection has been made. Consistent monitoring of the funds—to ensure they continue to serve participant needs—is central to the due diligence process,” concludes Fidelity.