The American retirement savings crisis has widened over the past 30 years with the demise of private-sector pensions. Defined contribution plans like 401(k)s and 403(b)s place the burden of saving and investing on the worker, but lack of financial education or experience has presented a major challenge to individual retirement savers. Policymakers have periodically attempted to address the crisis by encouraging plan sponsors to include automatic enrollment in packaged “set it and forget it” investment options like target date funds. These auto-piloted vehicles now predominate default options in most plans but are poorly understood, can be costly and vary considerably among fund companies that provide them.
For those disinclined to take action, a target date fund is far better than nothing. But it is still important to understand the basics before trusting your retirement security to any single Wall Street product.
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The Pension Protection Act of 2006 created a class of safe harbor investment vehicles that employers could select as default options for workers who did not enroll in their 401(k) or who neglected to select any investment options. One of these default options was the target date fund, a type of “fund of funds” that adjusts the mix of stocks and bonds over the working life of the investor up to and sometimes into retirement. These are easily recognizable by the target date in the fund’s name, generally intended to coincide with the investor’s estimated retirement date.
As an example, a 2060 TDF may start out with around 90-95% allocation in stocks. Over the lifetime of the fund, the allocation shifts gradually toward less risky investments like bonds and may end up with 30% or less in stocks by the target date. This gradual ramp is known as the glide path, and every fund adopts its own parameters for beginning, ending and intermediate asset allocation and timing. That makes comparisons especially difficult.