Target Date Funds – Can One Size Really Fit All?

Target Date Funds are a low maintenance investment option designed to automatically shift the asset mix out of equities and into fixed income, in tandem with a targeted retirement date. Also known as Life Cycle Funds—this pre-packaged investment option is designed to mimic what an investor should ideally be doing in terms of an investment strategy—participating heavily in equities when younger, then slowly moving into more conservative investment vehicles, such as bonds and cash equivalents, as retirement approaches.

The “autopilot” investment portfolio

To help avoid investment selection inertia, the industry has developed this easy to use, yet customized, portfolio of investments, based on the most important factor—when do you expect to retire. Target Date Funds are a sound option for apathetic investors, or those who are overwhelmed by the multitude of investment options available. With simplicity and asset diversification being the key strengths of this type of investment strategy, Target Date Funds are the perfect “autopilot” investment option. All that is needed is a target retirement date and automatic monthly contributions.

This “set it and forget it” approach is appealing within a group savings plan for a few reasons:

  • Investment coaching may not always be readily available to help plan members design their own diversified portfolio
  • Sophisticated savers can explore the endless world of mutual funds, exchange traded funds and direct stock purchases outside of a company sponsored plan, while still enjoying the relative ease of Target Date Funds in their group plan

One caution that younger savers hoping to use their company-sponsored Group Registered Pension Plan assets for a down payment on a home will want to consider carefully, is the risk associated with a Target Date Fund that aligns with their retirement date, but matures 30-35 years from now. Your investment “window”—and the purpose of your savings—should be a primary consideration when determining an investment strategy

Bridging the investment knowledge gap

 The extended time horizon for saving in a Registered Pension Plan makes Target Date Funds even more appealing. Often used as the default investment option, with Target Date Funds, pension plan sponsors no longer have to worry about an employee invested in Money Market or Daily Interest Accounts for prolonged periods of time. Designed to create a smooth glide path— the transition from more to less risk as an investor’s portfolio nears retirement—Target Date Funds help prevent knee jerk reactions by some plan members during volatile stock markets, and unlike a Group RRSP, Defined Contribution Pension Plan members have no access to their assets until at least age 55, or under very special hardship provisions, preventing those who may have a tendency to dip into their investments when money is tight from doing so. Ultimately, Target Date Funds can help bridge the gap between a member’s need to make wise investment decisions and their inability to do so based on a lack of interest, knowledge, and/or experience with investing.

The funds are one-size-fits-all—investors’ needs may not be

One of the most common criticisms of Target Date Funds is their lack of flexibility. For example, Target Date Funds do not account for risk tolerance. The philosophy behind these funds presumes that everyone who has the same target date will have the same investment profile—including the same risk tolerance—which is rarely the case. This is why some advisors argue that the original Target Date Funds are inherently too generic to meet the needs of individual investors. Because the asset mix within a fund can vary widely, it is important to understand exactly which assets are included in the fund and if the mix is compatible with your risk tolerance before investing.

Recently Target Date Funds with a risk overlay were introduced with moderate success. Although more customizable to the individual’s risk tolerance, this next iteration of the original Target Date Fund has now added a layer of complexity that is contrary to their original purpose.

Not all Target Date Funds are created equal. The glide path—which in part determines the ratio of equities to bonds within the fund—and the fees, can vary significantly. Every insurance company will also have a suite of Target Date Fund options to choose from, which can make comparison and the ultimate decision a challenge for the plan sponsor. Be sure to speak with a Cowan Insurance Group pension consultant when considering Target Date Funds in your investmen