Target date retirement funds emerged on the scene as investment vehicles about 10 years ago. Widely popular among 401(k) plan participants, the plans are designed to make retirement investing easier for those who lack the time or the expertise to manage their own retirement fund investments.
The plans are designed to provide a “plug and play” scenario for investors who begin by initially selecting their projected retirement date and then continually fund the account over the course of their career. The plan relies on a glide path investment strategy, which gradually rebalances the portfolio comprised of cash, bonds and stocks toward a more conservative investment allocation as the time for retirement nears. Despite the fund’s low maintenance philosophy, each target date fund has a different allocation model, and plan participants still need coaching and communication from plan sponsors to avoid making mistakes when investing, says Michael Ford, senior investment consultant with Watson Wyatt Investment Consulting, a subsidiary of Watson Wyatt Worldwide.
“As we study 401(k) participant behavior, aside from not saving enough for retirement, participants often fail to take enough risk, or they take too much risk with their fund choices,” says Ford. “In the case of target date retirement funds, a frequent participant mistake results from altering the asset allocation model by investing in more than one fund. All of these mistakes may cause 401(k) participants to be financially unprepared for retirement.”
Smart Business spoke with Ford about how CEOs can help employees invest wisely in target date retirement funds.
What is the most common investment mistake made by employees when investing in target date retirement funds?
The funds are designed to be all-inclusive investments. Frequently, plan participants become accustomed to spreading their investments among many different investment vehicles, like mutual funds, so naturally they are inclined to do the same thing with target date retirement funds. However, in this case, investing across multiple funds alters the glide path investment strategy, which, in turn, might cause plan participants to miss their financial retirement goals. It’s really not designed to be a mix-and-match investment concept.
How do retirement date funds fit into a plan sponsor’s full suite of investment options for employees?
It’s important to recognize that one size does not fit all when it comes to assisting employees with retirement planning. Each employee has a different risk tolerance, financial circumstance and level of investment savvy. We advocate structuring investment options into three tiers, with each tier appealing to different segments of the employee population.
- Tier one Target Date Retirement Funds: this tier is designed for participants who don't want to make asset allocation decisions and would rather have someone else do it for them.
- Tier two Core Options: this tier is designed for participants who want to make their own asset allocation decisions from a set list of investment options.
- Tier three Brokerage Window: designed for the small percentage of sophisticated investors who want maximum choice in their investments.
How can CEOs and plan sponsors help employees manage their retirement funds more effectively?
Communication and consultation with employees is absolutely vital. Plan sponsors should provide tools to participants that help them assess their risk tolerance and investment knowledge. If they are a tier one investor, it is important to communicate that this is a stand-alone investment option, not to be mixed with assets from the other tiers.
Plan sponsors should communicate with participants initially upon enrollment and then at least every six months about the nature of target date retirement funds and the investment strategy behind them. At Watson Wyatt, we recommend varying the communication method from print materials to in-person meetings to accommodate the needs of a diverse employee base.
What is the role of the plan sponsor’s record keeper in safeguarding employees?
Plan sponsors should coordinate safeguarding efforts with their record keeper to prevent tier one participants from mixing their allocations among other tier one funds or crossing their investments into the other tiers. Some record keepers are able to put safeguards in place that will not allow participants to mix asset allocations, so keep this in mind as you establish your selection criteria for record keepers.
With more and more employees taking on the responsibility of financially securing their own retirement, employers need to assist them by providing tools and the proper oversight of plan record keepers. Used properly, target date retirement funds can provide a majority of plan participants with a highly effective investment solution to help them save for their retirement
MICHAEL FORD is a senior investment consultant for Watson Wyatt Investment Consulting, a subsidiary of Watson Wyatt Worldwide. He is a seasoned professional with 23 years of extensive and diverse experience in the investment field. Reach him at (818) 623-4500 or firstname.lastname@example.org.