Fiduciary Handbook for Understanding and Selecting Target Date Funds: It's All About the Beneficiaries

Preface

Target date funds are a good idea that could become a great idea. It wouldn’t take much more to do what is best for beneficiaries. This handbook is normative. It explains what should be provided by target date funds.

Each Chapter has 3 sections:

1.          title

Statement of facts written by Ronald Surz, President and CEO of Target Date Solutions. During Ron’s 40 years of pension consulting he has advised several $ trillions, primarily on asset allocation and investment policy. He wrote the educational book on investment policy for Certified Investment Management Analysts (CIMAs). Ron is the sub-advisor of the SMART Fund Target Index offered by Hand Benefit and Trust, Houston.

2.          title

Legal guidance written by John Lohr, independent ERISA attorney and author. During his 40-year career, John has served as corporate counsel to E.F. Hutton and Lockwood Financial Group and has committed to improving the financial literacy of the investing public and their investment professionals. John’s most recent endeavors include the introduction of Fiduciary Forensics.

3.          title

Ethical Perspective written by Mark Mensack, Chief Ethics Officer of Mark D. Mensack, LLC. Prior to his 19 years in financial services, Mark taught philosophy and ethics at the United States Military Academy. Mark writes the 401k Ethicist column for the Journal of Compensation & Benefits

Many thanks to Sydney LeBlanc for her remarkable editing and Conor Byrnes for his masterful book creation.

Chapter 1

History

Target date funds (TDFs) were first introduced in the early 1990s by Barclays Global Investors (BGI) and were originally used for college savings plans. The target date, for example the 2020 fund, is an event date. In the case of college savings plans, it’s the year that a student intends to enroll in a college. Target date funds’ asset allocation mix typically provides exposure to return-seeking assets, such as equities, in early years when risk capacity is higher, and becomes increasingly conservative as time progresses with exposure switched progressively toward capital-preservation assets, such as short-term bonds. This asset movement through time from more to less risk is called a glide path. Eventually, target date funds began to be used for retirement savings plans, especially 401(k) plans. The event date in this application is the year in which an investor intends to retire.

Usage of TDFs remained minimal until 2006. Two major events brought TDFs to the forefront. First, behavioral scientists recommended that 401(k) plans use automatic enrollment to encourage participation. Employees would need to choose to be excluded from the plan, whereas they formerly needed to sign on for the plan. Behavioral scientists were right. 401(k) participation skyrocketed, but this created a new challenge. Many 401(k) participants were either unable or incapable of making an investment decision so they defaulted to their employers who, typically, placed their contributions in very safe assets, like cash. This led to the second major event: passage of the Pension Protection Act of 2006 (PPA).

Why is the Passage of the Pension Protection Act of 2006 Significant?

The PPA specifies three Qualified Default Investment Alternatives (QDIAs) that plan sponsors can use for participants who do not make an investment election: Target Date Funds, Balanced Funds, and