Young people hired at the University of Pittsburgh — from clerical workers to assistant professors fresh out of a Ph.D. program — are automatically enrolled in a retirement savings plan, but the majority of them fail to pick any investments.
When that happens, the contributions they make for retirement go into one of several target date funds that are programmed to invest the money in a portfolio of stocks and bonds that becomes more weighted with less risky bonds as the person gets older.
Target date funds are the default choice required by law when retirement plan participants don’t make any investment choices of their own. Some believe that might even be for their own good.
“Let’s say you are a new young faculty member and you studied languages or Italian history, you are probably not going to know a whole lot about investing,” said Jay Sukits, a professor of finance at the University of Pittsburgh and a member of the oversight board for Pitt’s $5.7 billion defined contribution plan.
“It’s an easy fallback to have your money go into one of these target date funds,” Mr. Sukits said. “At least you have a bit of comfort knowing your portfolio will get more conservative as you get closer to retirement age.”
Target date funds are essentially mutual funds that are pegged to a person’s expected retirement date. All the investor has to do is pick the mutual fund that matches the year they plan to retire, and the asset mix automatically rebalances as the years go by.
Also known as life-cycle funds and aged-based funds, they have solved a problem for workers of all ages, but most particularly young people overwhelmed with or uninterested in investment decisions.
A recent joint study by the Washington-based Investment Company Institute and the Employee Benefit Research Institute found younger 401(k) plan participants are most likely to use target date funds and hold a large portion of their retirement savings in them.
Recently hired workers — those with fewer than two years on the job — use target date funds at a higher rate: 57% compared to 54% of participants with five to 10 years of tenure. Only 36% of participants with more than 30 years of tenure used the set-it and forget-it style of retirement planning.
“Young people are more comfortable with the computer doing all the work for them,” said Adam Yofan, an adviser at Downtown’s Buckingham Strategic Wealth.
Mr. Yofan said the stakes are higher for older people near retirement. They often want to keep a closer eye on their money, which means taking a more active role in managing it.
“It takes more work to do this yourself,” he said. “Young people will take the easy solution because retirement is long way off and they’re more interested in other things. But a lot of old people don’t trust anybody — especially not with their money.”
Hands-off, but not risk-free
Target date funds took the retirement planning industry by storm in 2006 when the Pension Protection Act gave these retirement focused mutual funds the stamp of approval as qualified default investment alternatives.
That gave employers protection from liability if they automatically invested an employee’s retirement savings contribution in a target date fund when the employee had not otherwise made an investment choice.
Prior to 2006, money market funds were the default investment.
“Government regulators were concerned that people weren’t saving enough for retirement and not properly invested with a proper mix of stocks and bonds,” said Tim Walsh, a senior managing director at TIAA-CREF in Boston.
TIAA-CREF manages 15,000 retirement plans for colleges, universities and hospitals with more than 5 million participants in the plans. The company also provides financial guidance and education to its plan participants.
“Although people were saving, they were not prepared for retirement,” Mr. Walsh said. “Money market investment returns were not keeping up with inflation.”
Although target date funds had been around since the 1990s, there was a sudden explosion of assets flowing into them after 2006, and the popularity shows no signs of slowing down.
By 2008, Morningstar Inc. reported there were already 43 target date mutual funds, which had combined assets of $188 billion.
As of February, there are now 636 target date funds with $1.6 trillion in total assets, according to the Investment Company Institute in Washington.
With target date funds, the fund’s name often includes the retirement year, and they usually are spaced five years apart, such as 2020, 2025 and 2030.
Someone who is 39 now and wants to retire at 65 would select the 2050 fund. Over the 26-year period, that person’s money would start out more heavily weighted in aggressive, high-return stocks but with only a small portion in low-risk, low-return bond funds.
By 2050, the glide path is set for bonds to dominate the portfolio, reducing the risk that a market crash could destroy the nest egg.
However, target date funds didn’t fulfill that promise for many people who had planned to retire right around the time when the financial crisis of 2008 took a devastating toll on markets.
Although 2008 was an admittedly tough year for all investments, people in the target date funds targeted for retirement in 2010 lost an average of nearly 24% that year, according to the Securities and Exchange Commission. Losses in the 2010 funds ranged from 9% to a whopping 41%.
The workers who owned those investments assumed that their target date funds were more secure as the retirement date came closer, but they really had more exposure to the stock market than they thought.
In response, the Securities and Exchange Commission imposed new rules on the financial services industry, requiring that any marketing materials for target date funds disclose what the fund’s asset allocation will be on the target date.
Is it the right fit?
More workers are using target date funds than ever before. But critics of this solution to retirement planning doubt it can fit the needs of everyone who is retiring in a given year.
Wealth managers say workers also need to pay attention to what happens in the 30 to 40 years after their target retirement date.
“As I’m getting closer to a retirement date, the fund is selling stocks buying more bonds. Just because the calendar turns a page doesn’t mean I should automatically become more conservative,” said Chris Chaney, a vice president at Fort Pitt Capital Group in Green Tree.
One of the problems he often sees is people will choose multiple target date funds in their 401(k) which defeats the purpose.
“You end up with a blended version rather than a specific target portfolio,” Mr. Chaney said. “It doesn’t give you more diversification when you do that. They just overlap.”
Wealth managers are generally not fond of target date funds because they impose an asset allocation on clients that might not be appropriate based on their needs, circumstances or investment objectives.
Once the account builds up capital, they say the worker might be better off looking at other investing options that can help them achieve higher returns and also take advantage of tax savings opportunities, such as tax harvesting — which isn’t possible in a target date fund.
“As a one-stop shop for people who want a simple solution, they serve their purpose well,” Mr. Chaney said. “They are a better alternative than the old standby, which was a money market fund.”
This article originally appeared in the Pittsburg Post-Gazette.
