Offering a 401(k) plan is the first step toward helping your employees prepare for a financially healthy retirement. But it is important to structure the plan such that employees are most likely to reap its benefits. Beyond encouraging widespread participation and impactful savings rates, offering appropriate default investment options is a critical element to success. At ForUsAll, we recommend low-cost Target Date Funds (TDFs) as the Qualified Default Investment Alternative (QDIA).
A productive employee is not necessarily a good investment manager. Yet today’s employees are often asked to determine their own asset allocation, select their initial investments, and monitor these investments from enrollment to retirement. This is a daunting task for those with neither the expertise, time, nor inclination to manage their retirement assets. After all, you hired skilled employees–not financial advisors.
Fortunately, Target Date Funds can help your employees invest for retirement. A TDF sets the employee’s asset allocation, selects the investments, and manages the allocation while the employee is accumulating assets. At retirement, the employee can stay invested in the fund or take another approach with their 401(k) investments.
A TDF is constructed as a mutual fund made up of equity and fixed-income funds. What makes a TDF different from a traditional “fund of funds” is that the asset allocation automatically grows more conservative as time passes. A new employee who plans on retiring in 2039, for example, might select a 2040 TDF. Today, that TDF will have a far greater allocation to equities than fixed income assets, but each year the equity exposure will shrink, and the fixed income component increase. By 2040 the stock/bond mix will reflect the asset allocation deemed appropriate for a retiree by the TDF’s asset manager.
This gradual shift in the asset mix, known as the “glide path,” means that it’s not up to the employee to tweak allocations as risk preferences change.
The glide path offers another important advantage over a self-managed approach to 401(k) investing – automatic rebalancing. Rebalancing ensures the portfolio retains the appropriate asset mix regardless of market conditions. This prevents a booming stock market from elevating equity exposure, and keeps a flagging market from leaving the participant under-invested. Instead, a portion of the underlying funds periodically is bought or sold to keep asset allocations at the appropriate level.
Placing the asset allocation decision on autopilot also helps to prevent investors from making poor investment decisions in volatile markets. It is difficult for most of us to stick to our long-term investment plans when stocks are sinking. We want to sell equities, but usually after a big downdraft, and before an eventual recovery. If we allow TDFs to do the managing for us, the temptation to bail out in difficult markets is reduced.
Regardless of market conditions, the TDF dutifully guides the equity exposure lower over time while slowly ratcheting up the bond portion of the portfolio. TDFs remove the temptation to let our emotions get in the way of our retirement goals.
While TDFs are an important and relatively new investment tool, they are more like a box of chocolates than a Snickers bar. That is, not all TDFs are the same – and if your 401(k) advisor is acting as an investment fiduciary, it is their responsibility to find the right Target Date Funds for your employees.
Some of the most important variations among TDFs include differences in fees, funds, and allocations.
Fees among TDFs can vary widely, and high fee alternatives can result in lower asset values at retirement. Of course, target date funds from different providers are comprised of different funds. Some providers include actively managed funds in their TDFs, while others stick with (typically) lower cost passive investments. It’s important to look under the hood of TDFs to make sure the investments are understandable, transparent, and reasonably priced. At ForUsAll, we typically recommend Vanguard Target Date Funds, which are known for using low-cost, passively managed funds as their underlying investments.
At ForUsAll we work with you to find the right investments for your employees. We believe low-cost TDFs are a sound approach for most 401(k) participants, and that’s why our default investment options are low-cost target-date funds from Vanguard.
TDFs may be a “set it and forget” approach to retirement investing, but our technology-driven education can help your employees understand exactly how they work. For example, participants can learn the actual glide path of TDF funds at different target dates. We can even educate those employees who prefer an asset allocation at retirement different from that indicated by the glide path of other target date options. For example, some may prefer a TDF with different target date so that the target allocation more closely meshes with their retirement goals.
A successful retirement plan can boost overall employee satisfaction and even bolster employee retention. Middle-aged participants, in particular, may be less likely to look elsewhere if they are satisfied with the funding of their looming retirement.
Target date funds can be an important step in ensuring your employees get invested, stay invested, and invest in a manner appropriate for their particular retirement needs. In addition to high participation, these attributes can make your employer-sponsored retirement plan a rousing success.
Give your employees more than just a 401(k), join the movement.