Advisors Should Be More Rigorous In Selecting Target Date Funds For Clients

Thursday, April 28, 2011 12:11
Advisors Should Be More Rigorous In Selecting Target Date Funds For Clients

Tags: asset management | mutual funds

Most financial advisors choose target date funds (TDFs) offered by their bundled service provider for no reason other than familiarity and convenience. You can serve clients more effectively by using a more rigorous and objective selection process.

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Approximately 85% of the $350 billion in TDFs is invested with the three largest bundled service providers, even though there are a plethora of competing products. That would be OK if the objectives for these TDFs were well-conceived, but they are not.

TDFs are packaged for profit, so the focus is on products, not solutions. For instance, the ending equity allocations of the “Big 3” TDFs range from 30% to 60%. Choosing those funds exposes beneficiaries to substantial risk, as was painfully demonstrated in 2008.

Fiduciaries should always focus on appropriate objectives. The critical objective of a TDF should be preservation of capital – don’t lose participant money, especially near the target date. No guarantees of course, but this is a much more realistic objective than replacing pay or managing longevity risk, which are the common objectives for TDFs.

Furthermore, TDFs should have investment policy statements because, as default investments, they are employer-directed. Participants do not choose TDFs so they have no idea what they are. Fred Reish, a prominent ERISA attorney, recently recommended investment policy statements for TDFs.

For a sample TDF investment policy statement, see the Safe Landing Glide Path.

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