Readers Select Top Fiduciary Stories of 2009: #8 The Fall of Target Date Funds
It all started a few years ago when Congress passed the Pension Protection Act of 2006 (“PPA”). The PPA featured an automatic enrollment option, but created a void that perplexed – and possibly increased the liability of – the typical 401k fiduciary. In October 2007, the Department of Labor (DOL) came to the rescue by issuing a final rule establishing qualified default investment alternatives (QDIAs). This made it easier for employers to automatically enroll workers in their 401k and other defined-contribution plans.
According to the DOL Fact Sheet , among the three types of QDIAs included “a product with a mix of investments that takes into account the individual’s age or retirement date (an example of such a product could be a life-cycle or targeted-retirement-date fund).” With this boost, interest in Target Date Funds (“TDFs”) rocketed and, at the height of their enthusiasm in 2008, industry analysts expected the product to surpass the $1 trillion mark by 2012 (“Target date funds set to surpass $1T by 2012,” Investment News, October 5, 2008). By comparison, it took nearly 30 years for index funds to surpass a trillion in assets. What caused this popular product to miss its mark?
Pitched as the be-all-and-end-all to 401k investors, these funds fell flat on their collective face as 2008’s down market exposed them as more sizzle than steak and left the DOL a bit red-faced. Shareholders – red-faced in another way – clamored and Congress, in response to these irate investors, set up several hearings on this relatively new product throughout 2009 (see “Target-Date Funds Go Under the Microscope,” USNews.com, October 30, 2009). Congress has yet to take definitive action, but the industry is not waiting. Roger Wohlner, CFP®, recently listed by the Wall Street Journal as the #1 financial blogger in the country, summarizes the issue when he told FiduciaryNews.com “The fact that there is such disparity between the holdings of various target funds with the same target year (say 2010 for instance) is a problem.”
But 2009 exposed a much deeper problem with TDFs. Each TDF assumes a “glidepath” – a theoretical contribution/distribution timeline for investors. Unfortunately, recent evidence suggests investors don’t behave in the manner the typical glidepath suggests (see “Participant Behaviors do not Match Target Date Assumptions,” PLANSPONSOR.com, January 11, 2010).
Perhaps Mr. Wohlner offers the best advice. “TDFs probably remain a viable default option, but some changes need to be made. Participant education ought to include a ‘truth in advertising’ how-to that enlightens them of the vast differences in the allocations of TDFs with the same target year. Washington might help, too, but not by merely holding hearings and pontificating for their constituents. They need to take a hard look at what is both right and wrong with TDFs. A knee-jerk reaction to 2008 is not a good solution at all.”