What if Congress passed a law to help investors, and it actually did? About a decade ago these pages covered a pressing problem with participant-directed 401(k) retirement plans. A lot of those participants weren’t showing much interest in self-directing their investments. At the same time, employers and plan trustees didn’t want the liability of automatically steering those accounts into anything but the most conservative alternative, often a money market fund.
Letting retirement savings idle away the decades at short-term interest rates seemed a dubious strategy. Enter the Pension Protection Act of 2006. One provision of that huge legislation laid out guidelines for something called a Qualified Default Investment Alternative (QDIA). Plans could automatically direct participant contributions into investments meeting those guidelines and be substantially insulated from liability.
Investment companies responded with a proliferation of target-date retirement funds, the most familiar type of QDIA. As these pages have previously discussed, target-date funds are broadly diversified allocations designed to gradually shift their holdings as the targeted date draws nearer. Such funds now hold more than $755 billion in assets, up ten-fold in less than a decade.
Of course, popularity is not always predictive of great investment results, and investors are notoriously poor timers. Over the years a host of studies have indicated that the actual returns experienced by mutual fund investors typically fall short of the performance of the funds they hold. But the popularity of target-date funds is not a case of chasing hot market sectors or stocks.
Mutual fund researcher Morningstar studied investor experience across the dozen fund companies that had target-date offerings for the full decade ended December 31, 2014. Morningstar found that, on average, those investors experienced somewhat better returns than the funds themselves. On an asset-weighted basis, their average annualized return was pegged at 6.13% compared to 5.03% for the funds. That advantage appeared not to be a fluke, as it appeared in eight of the 12 fund companies studied.
Retirement plan trustees and participants will want to understand and monitor the target-date funds available to them, their ongoing expenses, and the manager’s approach to modifying allocations along that specified glide path to retirement. That said, the primary value may be the target-date concept’s reinforcement of basic precepts of retirement investing such as:
• Focusing on long-term objectives rather than short-term volatility and performance;
• Maintaining broad diversification through multiple market cycles;
• Saving regularly and persistently.
So far, targets seem to help.