401(k) Specialist Issue 2 - 2016 - 22

CLIENT CONNECTION by Nick Della Vedova
How to Deal With 401(k)Target Date
Funds' Fatal Flaw
THE TARGET DATE FUND STORY is supposedly
elegant and simple-select the
date around when the participant plans to
retire and the fund will take care of everything.
As the retirement date approaches,
the TDF will rebalance to a more conservative
mix, and manage that mix not only
into retirement, but throughout it as well.
The TDF is a " one stop shop " where the
participant can " set it and forget it. "
If only it were that simple.
The TDF has proven to be no silver
NICK DELLA VEDOVA
bullet for plan participants. While the TDF
may have made the investment decision
easier, it did not necessarily make the
retirement outcome better. It's true that
TDFs are likely better than having participants
attempt to build their own asset
allocation, but, is it really that difficult?
Simply ask a participant to explain the
difference between stocks and bonds. If this leads back to the TDF, what next? If the TDF
isn't the answer, what is? How can participants make a better investment decision when
the very solution touted to do so fails in its endeavor?
It may help by first understanding the TDF's flaw, which is the assumptions it must
make. Every TDF makes assumptions about risk, future returns and funding levels. Among
all of the assumptions lies the most important assumption of all-the savings rate. As the
saying goes, " 10 percent of nothing is nothing. " While investment assumptions are important
to the investment mix and the optimal target date fund, the participant savings rate
and the degree to which they are funding their retirement is critical. The highest earning
TDF will never get participants to where they want to be if they haven't saved enough in
the first place.
Which leads to the most important point-target date providers make different assumptions
about participant savings rates. Assumptions are made based on and for the
average participant. Even then, assumptions vary greatly. Those most disadvantaged by
the " averages " assumption are the participants not saving enough, as well as participants
purportedly doing well for themselves by saving more than enough. These two groups are
severely underrepresented when using averages. The industry, in general, thinks participants
don't save enough.
Acknowledging this, how do we make the investment decision better for participants if
it's not TDFs? Surely participants can't do this themselves, or can they?
Yes, they can. When the savings rate and funding for retirement plays such an integral
22 ISSUE 2 2015 | 401kSpecialistmag.com
''When the
savings rate
and funding
for retirement
plays such an
integral role in
retirement, it
is easier than
you think.
''
role in retirement, it is easier than you
think. Defined benefit plans call this " liability
driven investing " (LDI). The concept
simply refers to the amount participants
saved (funded status) and its integral role
in asset allocation. For participants on
track to save enough, their asset allocation
should be more conservative than
participants who are barely funding their
plan. Late savers need to take more risk
in their portfolio if they hope to retire as
successfully as the participant who has
saved enough.
Nick Della Vedova is president of Retirement Plan
Advisory Group in Aliso Viejo, California.

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401(k) Specialist Issue 2 - 2016

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