A higher level of interest in target-date funds springs from the market meltdown of 2008 and 2009, when participants in TDFs that were nearing the target date experienced losses that were far beyond expectations. Unfortunately, participants in these near-year TDFs didn't think that they were taking on as much risk as they were. This misperception arose from a lack of understanding about the funds' glide paths.

The term "glide path" is used to describe a TDF's risk profile. It refers to the percentage split between equity and fixed income investments in the TDF and how that split changes as the years go by. This change is best illustrated visually, using a graph to plot the equity percentage of the fund at various points in time. The expected result is a sloping curve, higher in the far-off years, like 2055, due to the higher equity percentage in the fund in those years, and lower in the near years, like 2015, as a result of the decreased equity percentage. Many investors in TDFs assumed that the equity percentage in the near-year funds would be quite low. However, that may not have been the case for anyone who invested in a "through" target-date series rather than a "to" target-date series.

As TDFs evolved, fund companies realized that not everyone was withdrawing their account balance at the target date and using it to fund their retirement. Most fund companies observed that many participants were leaving their money in TDFs for an extended period of time. In many cases, participants didn't withdraw their balances at all. As a result, the "through" retirement approach to managing TDFs emerged.

Since it became apparent that many participants were going to leave their retirement plan balances in their TDFs many years beyond the target date, the longer investment time horizon that resulted required a higher equity percentage allocation in the near-year funds. Those fund families that operated under the assumption that participants really weren't going to be withdrawing their money at the target date began offering glide paths that did not terminate at the target date, but instead ended five, 10 or more years after the target date. These TDF series became known as "through" target-date series because they managed investor's balances beyond the stated target or retirement date. Those fund companies that offered TDFs that had glide paths that terminated at the target date became known as offering "to" target-date funds.

Clearly, these two concepts, glide paths and to/through, are not easily understood by most participants. Are there benefits in offering these funds that outweigh the difficulty in understanding how they work?

Target-date funds have the ability to function as a 401(k) plan's qualified default investment alternative. Remember that plan sponsors may gain protection against liabilities from losses when they designate a QDIA as an investment vehicle for those participants for whom they do not receive investment elections.

Many 401(k) plan investors are reluctant participants in their company's 401(k) plan. They realize they need to save for retirement but have no time, interest or skill in managing an investment portfolio. TDFs essentially fulfill these participants' needs for professional portfolio management in a quick and efficient way.

Participants have become more familiar with target-date funds since it is common for plan sponsors to offer them in their 401(k) plan. A 2008 Deloitte and Investment Company Institute study found that 72% of 401(k) plans offer TDFs. And, with their set-it-and-forget-it approach, TDFs are easy for plan participants to use and don't require much maintenance.

One of the biggest challenges in offering TDFs and ensuring that your participants use them appropriately is educating participants on their use. Much time has been spent by talented educators trying to explain the glide path and to/through concepts. As demonstrated by investor reactions to the 2008-2009 market crash, the majority of TDF participants never fully understood these concepts.

If you currently offer a target-date series, or intend to begin offering one, educating participants about TDFs should be an important goal. This may be an excellent time to focus the majority of your annual employee education initiative on TDFs. After what happened in the markets in 2008 and 2009, plan participants may be listening more closely now.

Contributing Editor Robert C. Lawton is a member of the Madison, Wis. Graystone Consulting team specializing in retirement plan advisory services. He is a Chartered Retirement Plan Specialist. He can be contacted at robert.lawton@morganstanleygraystone.com or 608-283-2304.

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