Why TDFs are the best 401(k) plan option

Commentary: There has been quite a bit written recently, most of it negative, about target-date funds. It is hard for me to understand why since they provide 401(k) plan participants with:

• Professional investment management at a low cost. Most 401(k) plan participants, if they purchased similar investment management services from a broker, would pay between 1.5% and 2%. Nearly all target-date funds have expense ratios well below 1%.

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• A convenient way to invest. Target-date funds provide an accessible and efficient approach to investing for those "set-it and forget-it" 401(k) plan participants who wish to spend as little time as possible managing their account. Keep in mind that the vast majority of your 401(k) plan participants embrace this investment philosophy.

• Flexibility. There is a target-date series for every employee population with choices that include passive or active management, "to" or "through" target dates and varying glide paths. Participants can take more risk by investing in an option with a target date later than their recommended fund, or less risk by investing in a nearer dated fund.

• A better option than target-risk funds. Target-risk funds (i.e., conservative, moderate, aggressive) are fatally flawed since they require 401(k) plan participants to change the fund they are invested in when their risk tolerance changes. Participants experience changes in their ability to bear risk as they age or when they have a change in family status. Most participants in risk-based funds never take the time to change their investment election and, as a result, often end up in a fund that is too risky. These participants learn they have taken on too much risk when the market falls and they experience losses which are beyond their expectations. Target-date funds have professional managers who adjust the risk profile of the fund as time goes by to account for changes in participants’ risk tolerance as they age.

• A much better option than traditional balanced funds. Like target-date funds, balanced funds provide exposure to both stocks and bonds. However, balanced funds do not offer participants a way to adjust their exposure to stocks and bonds as they age.

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• A much, much better option than previous options. Target-date funds provide much better investment solutions than anything that existed previously for those "set-it and forget-it" 401(k) plan participants. Keep in mind that before target-date funds became widely used, these participants might choose where to invest based upon advice gained from a brother-in-law or some other less-than-appropriate source.

Full disclosure: I derive no benefit from saying nice things about target-date funds. Although target-date funds might not be perfect for everyone in your plan, remember that the target-date concept is still in its infancy. Expect these professionally managed investment options to become an even better fit for your 401(k) plan participants as time goes by.
Robert C. Lawton, AIF, CRPS is President of Lawton Retirement Plan Consultants, LLC, a RIA firm helping retirement plan sponsors with their investment, fiduciary, employee education and compliance responsibilities. He may be contacted at bob@lawtonrpc.com or 414.828.4015.