Issues with Target Date Funds

Honeywell pension plan

401K Specialist Magazine has an interesting article about target date fund lawsuits. It’s worth a read if you manage a plan.

While target date funds are great choices for most 401(k) plan participants, we’ve never been completely comfortable with them.

For starters, there are issues with monitoring the funds as many of them have differing underlying allocations to stocks/bonds, etc. This can create a situation where Fund A may under or out perform Fund B based solely on allocations to various parts of the market (e.g. a choice to have more international stocks may have been prudent but ends up hurting performance when they lag).

Secondly, and more importantly, is that most 401(k) plan participants simply may not have a clear understanding of how much risk they are taking. Especially when they need it most! What I’m talking about are pre-retirees, folks who generally have the largest balances and are retiring soon.

For example, the vast majority of 2020 target date funds have a 50%+ allocation to stocks. It’s not hard to imagine a serious bear market disappointing the pre-retiree who thought her money was in a conservative portfolio (when in fact most of the 2020 funds would be considered a moderate allocation).

In our opinion, the solution is to have allocated portfolios that are target “risk”. For example, having conservative, moderate and aggressive portfolios available. Most 401(k) investors can understand that with ease and are less likely for an unpleasant surprise.

About Michael McGinley, CFP®, AIF®

Michael McGinley has worked in the financial services industry for over 15 years. He is currently a partner at Providus Advisors, an investment advisory firm located in Chandler, AZ.

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