As target-date funds continue to grow in popularity as an option for saving for retirement, some experts question whether they are achieving their goals, but say they remain a good default plan.
In 2004, just 13% of defined contribution plans offered a TDF option. That rose to 84% in 2012, according to Vanguard data. The company estimates 55% of all participants and 80% of new plan entrants will be entirely invested in a professionally managed allocation by 2017.
But Erik Carter, senior financial planner at El Segundo, Calif.-based Financial Finesse, a nationwide provider of unbiased financial education, says the plans do not work right for most people. First, he says they are not personalized to an individual's risk tolerance level since they are based on age. You could have someone who is young and conservative with savings, or an older person who has a large pension. Further, they fail to consider outside assets, including stock holdings and IRAs.
Carter says the biggest issue is that no one has questioned the main premise of the funds - being more conservative closer to retirement age. He points to research that has found that exactly the opposite should be the case, because when you are young you have the least amount of money in the plan and are the most aggressive - and have the most potential for earnings.
Another criticism lies in the fact that a large percentage of plan sponsors use TDFs that are pre-packaged vendor products, and that an investment management firm may also serve as the plan record-keeper, according to a Hewitt EnnisKnupp white paper. "The sole means of control over TDF quality and cost is at the product level, where plan economics and vendor platform structure often dictate the availability and extent of product choice," the white paper says.
Still, since consumers are unable to make their own portfolio, the industry responded with TDFs as a viable solution for most, says Jean Young, a senior research analyst in Vanguard's Center for Retirement Research in Valley Forge, Pa.
The cost of TDFs is an issue as well, since they are historically actively managed. The funds, Carter says, have high fees and can easily be replicated with lower-cost funds in a plan by using an index fund to create a customized and personalized TDF.
The retirement companies recognize this and explain they are working on it. "[Costs] are definitely a challenge and there are certainly things you can do," says Jeff Tyler, portfolio manager for lifetime funds at The Principal Financial in Des Moines, Iowa. He adds that Principal tells plan sponsors to always ask how to manage costs and bring the cost of the plan down.
Young agrees, but notes that cost is the biggest predictor of beating the market in the future. "Our product is low cost because it is indexed," she explains.
In the end, Carter believes that TDFs are not a terrible option and make a good default plan, rather than an employee leaving their retirement money in a low-earning basic account. The TDFs, he says, are better than someone just picking on their own. But, there remains "an opportunity for education to help people and explain, 'Here is how you can do it better than a target-date fund.'"
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