Many years ago, when target date funds were in their infancy, a client inquired of my thoughts concerning these funds, as an investment option for a 401(k) plan. The VP of investments for the company joined the discussion. Eventually, a finance professor from the University of Chicago was added to the mix. All things considered, it was decided it was best to exclude these funds from the lineup.
Why? First, there was no “accepted” blend of stocks and bonds (or other assets) for any age group (and the proposed fund was to convert to all, or substantially all, bonds by the age 65 target date). Second, based on differing genes, etc., individual life expectancy can vary greatly. Finally, there was little flexibility to deal with unique circumstances, such as those mentioned in the immediately following paragraph.
Currently, bond yields are at or near all-time lows. While Federal Reserve chairman Ben Bernanke has said rates will stay low for at least a couple more years, there are no guarantees (including the ability of the Fed to make the calls). What will happen if the economy picks up substantially over the next year? As interest rates climb, ordinarily, the value of existing bonds (and funds holding bonds, including target date funds) falls. While bonds may diminish in value (potentially substantially) in the next few years, there appears to be little upside to them relative to other available investment options.
Does this mean bond investments are imprudent (and, thus, should not be held by any retirement plan)? No. But, prudent fiduciaries should recognize the situation, understand the inability of most employees to understand investing in general, and act accordingly. Now would be a good time to analyze disclosures relating to investment options holding bonds.
Assuming diversified stock and bond funds exist for a 401(k) plan, participants can assemble a target date for themselves if the so desire. Disclosure documents can be provided that discuss the risks of various investments and things that impact them, including the impact of interest rate changes on bonds. These disclosures should be written so that someone who is not knowledgable about investments can understand them. It is difficult to do, but it can be done.
The “auto-pilot” nature of target date funds makes them appealing to sponsors, fiduciaries and participants. But, should interest rates increase substantially, some particiopants may sue, alleging they were effectively steered towards target date funds. All things considered, excluding these funds from the mix and including a solid investment explanation (including experience) along with diversified stock and bond funds probably is the best course of action.
which found that while target-date funds were generally a welcome innovation, diclosure had to be improved to ensure investors were fully aware of a target-date fund glidepath, which may differ from manager to manager. The rules on disclosures for target-date funds were published by the SEC in 2010.
A target-date fund typically consists of other mutual funds and exchange-traded funds. What makes a target fund different from other funds of funds is that the fund’s portfolio shifts over time. As you get closer to retirement or some other milestone (that is, the “target date,” such as 2030, that’s in a fund’s name), the fund becomes less risky. When you hit the date, you don’t have to sell—most of the funds are built to be held during retirement, too (see When a Target Fund Nears Its Target ).
which found that while target-date funds were generally a welcome innovation, diclosure had to be improved to ensure investors were fully aware of a target-date fund glidepath, which may differ from manager to manager. The rules on disclosures for target-date funds were published by the SEC in 2010.