Target Date Funds: Structurally Unsound

Posted: 2 Apr 2013 Last revised: 13 Nov 2018

Date Written: April 1, 2013

Abstract

Target Date (“TD”) mutual funds suffer from serious flaws: their performance is difficult to evaluate due to multiple layers of active management; they are expensive due to heavy reliance on active equity managers, and as such are priced (and behave) like actively-managed equity funds; and, actively-managed TD funds likely cannot, I will argue, (and apparently have not), on average, add (added) alpha over time.

As a result of these flaws, most TD funds may amount to no more than an expensive way of accessing a mix of “betas.” The fact that such an approach may represent an improvement over an uninformed participant attempting to manage their retirement account does not excuse these flaws.

The presence of serious structural flaws in the current generation of TD mutual funds suggests that most but not all such funds should be avoided by plan sponsors and investors, or at the very least used with extreme caution.

Though a worthy idea, the TD fund concept appears to have been implemented hastily and poorly, on average. As with the 401(K) plan itself, the TD mutual fund has arguably become a vehicle for asset gathering by mutual fund managers, with only secondary emphasis on improving participant retirement security. While TD funds may be better than “going it alone” for most participants, clearly there is room for substantial improvement in their management.

Until the structural defects identified in this paper are corrected (and we should not hold our breath), plan sponsors lacking investment expertise should consider either using passively managed offerings exclusively, or hiring an adviser to build, manage and be accountable for the performance of “custom” TD funds.

Keywords: Target Date, Target Date Funds, Life Cycle, Life Cycle Funds, Defined Contribution, 401(K)

Suggested Citation

Fandetti, Marc, Target Date Funds: Structurally Unsound (April 1, 2013). Available at SSRN: https://ssrn.com/abstract=2243185 or http://dx.doi.org/10.2139/ssrn.2243185

Marc Fandetti (Contact Author)

P-Solve ( email )

Boston, MA
United States

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