Target date funds are popular options for employer-sponsored retirement plans. As the name suggests, target date funds are chosen based on the estimated year you plan to retire. For example, an employee who is about 14 years away from retirement would choose a 2030 target date fund. In this type of fund, the investment strategy is tailored to be more aggressive the further you are from retirement and become more conservative as you get closer to your “target date”.
Demographics of Employees
The first thing to consider when selecting target date funds for your retirement plan is the overall demographics of your plan participants. This information will help you determine the right mix of target date fund families to focus on. Keep in mind that you will need to diversify your plan offerings to meet the different needs of your employees.
Target date funds are beneficial to employees who want a more automated solution that will adjust to their needs over time. Working backwards from their retirement date and taking into account a participant’s unique risk tolerance can help you determine which target date funds are right for your employees.
Asset Classes
Target date funds offer a broad mix of asset classes in order to diversify participants’ portfolios. Spreading your investments across different asset classes such as stocks, bonds, and marketable securities limits your overall portfolio risk. How much is invested in each asset class at any given time is determined by the participants’ long-term investment goals.
“To” or “Through” Retirement
The next step is to determine if your plan participants are going to keep their money in their target date fund “to” or “through” retirement. Knowing their long-term investment goals will help determine how aggressive or conservative to make the investment strategy of the target date fund. A participant who plans to keep their money in the fund through retirement will need a far less conservative target date fund than someone who plans to take their money out as soon as they retire, as they will need their money to keep growing to support them. Obtaining data on your plan participants’ preferences is key to determining the right mix of glide paths for the target date funds you will offer.
Decide on Glide Path Structures
Target date funds are not a one-size-fits-all solution. Each group of target date funds have a different glide path, which refers to the calculation to determine how assets are allocated in the investment fund. In order to select target date funds to offer in your retirement plans, you must decide how many different types of glide paths you will provide. Some funds will switch to a conservative strategy a few years before the retirement “target date” and others will gradually transition over a longer period of time. Providing multiple options and educating your employees of the benefits and risks of each is essential.
Inclusion of Non-Correlated Assets
When deciding on a glide path, it is important to consider how the inclusion of non-correlated assets can help reduce overall risk. When assets are non-correlated it means that a price fluctuation for one asset does not necessarily affect the price of the other assets. To achieve a healthy mix of non-correlated assets in your target date fund you must diversify the types of assets by including a combination of stocks, bonds, and cash. Use an asset class correlation tool, such as Portfolio Visualizer, to see a correlation matrix for typical funds.
Target date funds are beneficial to employees who may not know how to spread their retirement investments across different asset classes on their own. These types of funds are rebalanced across asset classes throughout the years in order to stay in line with market fluctuations and the overall goal of the fund.
How I Can Help
There are so many choices to consider and I know that you want to create the most useful and beneficial retirement plan options for your employees. I am here to help. Call me today at (312) 973-4913 or email mark.olsen@planpilot.com. I can walk you through the process of selecting target date funds and help you consider every avenue in order to make the best decision for your employees.