In recent years, target date funds (TDFs) have become a popular investment option for many 401(k) plan participants. By investing in a mix of stocks, bonds and other investments, often through investments in other mutual funds, TDFs are designed to provide a one-stop, long-term investment strategy tied to a participant’s anticipated or “target” retirement date. Generally, TDFs invest heavily in stocks and other riskier assets in earlier years and then shift to less risky assets as the target retirement date draws near. This automatic shift in the asset allocation, which is known as the fund’s “glide path,” relieves the participant of the often confusing chores of selecting the proper asset allocation and rebalancing investments.
Some TDFs use a “to retirement” glide path, while others use a “through retirement” glide path. The “to retirement” glide path will reach its most conservative point at the target retirement date, whereas the “through retirement” glide path will not reach its most conservative point until some years after the target retirement date.
With the growing popularity of TDFs, the Department of Labor (DOL) recently released a set of guidelines, which can be found here, to help plan fiduciaries in selecting and monitoring TDFs. A brief summary of the DOL’s guidelines follows:
- Establish a process for comparing and selecting TDFs. As with any other investment option, plan fiduciaries should engage in an objective process to obtain information that will allow them to evaluate the prudence of any TDF offered under the plan. Information to be considered should include fund performance and investment fees and expenses.
- Establish a process for the periodic review of selected TDFs. Plan fiduciaries are required to periodically review the TDFs offered by the plan. The review process should include examining whether there have been any important changes to the investment options since they were selected such as whether the TDFs investment strategy or management team has changed significantly.
- Understand the fund’s investments – the allocation in different asset classes (stocks, bonds, cash), individual investments and how these will change over time. Plan fiduciaries should understand the principal strategies and risks of the fund including the TDF’s glide path.
- Review the fund’s fees and investment expenses. Plan fiduciaries should understand both the amount and types of fees. If the TDF invests in other funds, plan fiduciaries should also consider the fees and expenses for the underlying funds.
- Inquire about whether a custom or non-proprietary target date fund would be a better fit for your plan. Many TDFs invest exclusively in the other mutual funds offered by the sponsor of the TDF. Custom, non-proprietary funds may offer advantages to plan participants by diversifying their exposure to funds managed by fund managers other than the TDF provider. Custom, non-proprietary TDFs are typically only available to larger plans and any additional costs or administrative tasks should be considered.
- Develop effective employee communications. Plan fiduciaries must consider any disclosures required by law, but should also provide appropriate information to employees about the TDFs as a retirement investment option.
- Take advantage of available sources of information to evaluate the TDF and recommendations you received regarding the TDF selection. There are several commercially available sources of information and services to assist plan fiduciaries in their decision-making and review process. Information also is available from the SEC here and here.
- Document the process. Plan fiduciaries should document both the selection and review process.
Plan fiduciaries are not required to follow the DOL guidelines, but they provide a good checklist of what the DOL considers to be prudent conduct in selecting and monitoring TDFs.