Construction executive Bob DeSmidt sat through a conference session last year on target-date funds. It seemed like the usual talk until the speaker said that while many 401(k) plan sponsors offer the investment, few know exactly what they are getting.
DeSmidt, the chief financial officer of Sioux City, Iowa-based Klinger Cos., is in charge of the company’s $31 million 401(k) plan, and it sounded as if the speaker was talking directly to him.
“Sitting through that session was a wake-up call for me,” DeSmidt says. “I thought this was an area we needed to pay more attention to—not that we ignored it, but we needed a better understanding of the nuts and bolts.”
Target-date investments have been around for about 20 years, but the funds are hitting a critical point, experts say. Now that defined contribution plans are the way most Americans save for retirement, and target-date funds are increasingly becoming the most popular investment in many 401(k) plans, many employers who offer the strategy say they will take a hard look at them this year.
“Plan sponsors have more options [with target-date funds] today than they did even a decade ago,” says Winfield Evens, director of HRO investment strategy and partner at consulting firm Aon Hewitt. “Examining what the right fit is [for the 401(k)] is a very healthy process for the plan fiduciary.”
In January, Aon Hewitt’s 2013 Hot Topics in Retirement survey of 428 employers showed that about three-quarters, or 76 percent, of companies offer target-date funds as a simple way to invest. More than half of these companies say they will do a comprehensive review of the fund manager this year, and nearly the same say they plan to examine how the investments shift as they near the target date.
“Plan sponsors are taking their fiduciary responsibilities very seriously—in particular looking at target-date funds,” says Jeff Vorwerk, director of investment services for investment manager Principal Financial Group. Because target-date funds “have such a large share of plan assets, plan sponsors are examining the underlying components of their target-date portfolios.”
Target-date funds, also known as “lifecycle funds,” have become more popular with plan sponsors and participants because of the ability to “set it and forget it.” With minimal effort, participants can pick or get automatically assigned to the fund that best matches their retirement date. The fund is professionally managed, and investments in it are put on a “glide path”—the course where the fund becomes more conservative as the participant nears that target date.
But while funds may have the same end date, the investments used in each portfolio can vary, experts agree. Ending in the same year can be misleading because certain investments in each fund might be too risky for participants in the plan, says Caren Bianco, director of investments for PricewaterhouseCoopers. That is why plan sponsors need to make sure the investment strategy—the glide path—to more conservative options best fits the overall needs of plan participants, she says.
“Managers are forever tweaking what is in the glide path” of their target-date funds, Bianco says. Plan sponsors must make sure the glide-path strategy aligns with the demographics of the participants, she adds.
The first basic component to understand is the “to” vs. “through” strategy, experts agree. “To” funds generally wind equities down to the retirement date. “Through” funds manage equities beyond the retirement date to help account for people living longer lives and still needing that exposure to help their money last through retirement.
It can be tough for plan sponsors to figure out exactly what may fit for their workers, so in February the U.S. Labor Department issued a tip sheet for picking a plan.
Because investment strategy “differences can significantly affect the way a TDF performs, it is important that fiduciaries understand these differences when selecting a TDF as an investment option for their plan,” the tip sheet says.
Among its recommendations, the Labor Department suggests plan sponsors establish a process for comparing and picking target-date funds, create a periodic review process and understand how the investments in the fund will change over time. It also recommends developing strong employee communications so workers understand the investment.
Klinger Cos. did its review in 2011 and decided to stay with the target-date fund lineup offered by Principal. The “through” concept used makes sense, DeSmidt says, because before introducing target-date funds about eight years ago, most workers were heavily invested in conservative guaranteed investment contracts. Because many workers had an overly conservative investment plan before the target-date introduction, the “through” strategy made sense so employees could have a little more time to possibly make larger gains, DeSmidt says.
“When we have an employee retire, the first question is, ‘How much is in my 401(k) plan?’ ” DeSmidt says. “With target date [funds], we feel we give them a great investment option to get people retirement-ready.”