An analysis of target date risks and alignment with Plan Sponsor objectives
Key Observations
• The Qualified Default Investment Alternative (QDIA) investment decision is among the most important investment-related decisions a Plan Sponsor will make on behalf of its participants. The selection of a target date fund is likely to have the greatest impact on the largest number of participants and their ability to achieve their retirement objectives. Target date products are relatively immune to participant inaction because they evolve as participants age. This characteristic makes target date funds the most attractive QDIA and the most complex alternative. Because the decision is so critical, it carries major fiduciary implications.
• To prudently select and monitor a target date fund, a Plan Sponsor must understand its unique characteristics and align those features with the objective set for participants. A Plan Sponsor may choose to prioritize one of two competing objectives: the probability and level of real income replacement during retirement or to reduce the volatility of account balances. In industry jargon, these two objectives are often referred to as longevity risk and market risk, respectively.
• No single target date fund can prioritize both of these objectives simultaneously. Therefore, the Plan Sponsor must decide which objective is most important for its unique participant base. Objective analysis of Plan demographic information can help inform this discussion, but the preferences of the Plan Sponsor should play a role in the decision. The efficacy of the target date fund selected will depend on aligning the Plan Sponsor’s objective with that of the target date.
Introduction
Historically, retirees with both a Defined Benefit Plan (DB) and Social Security could replace a reasonable portion of their final salary in retirement. Those income streams in retirement usually rose with inflation and paid the retiree in perpetuity. Unfortunately, that experience is unlikely to endure in the future. The secular decline in the use of DB retirement Plans has placed a larger and increasing saving and investment burden on individuals. Grasping this new and complicated responsibility is important for participants and Plan Sponsors alike because the Defined Contribution Plan (DC) will likely become the primary investment vehicle for the majority of future retirees.
Sufficient Retirement Income = Adequate Savings + Appropriate Investing
While we will focus on the “Appropriate Investing” component of the equation above, we cannot continue without first stressing that inadequate savings rates cannot be overcome by even the most successful investment strategies. Saving more and saving early has been and will likely always be the primary determinant of retirement success or failure. Plan design that encourages adequate savings early must be a priority.
The information contained herein is confidential and the dissemination or distribution to any other person without the prior approval of Fiducient Advisors is strictly prohibited. Information has been obtained from sources believed to be reliable, though not independently verified. Any forecasts are hypothetical and represent future expectations and not actual return volatilities and correlations will differ from forecasts. This report does not represent a specific investment recommendation. The opinions and analysis expressed herein are based on Fiducient Advisor research and professional experience and are expressed as of the date of this report. Please consult with your advisor, attorney and accountant, as appropriate, regarding specific advice. Past performance does not indicate future performance and there is risk of loss.
