Target date funds (TDFs) have become a popular choice for the average investor, especially within employer-sponsored retirement plans, due to several advantages over managed accounts. Here’s a brief explanation of why TDFs are often considered a superior choice for many investors:
- Simplicity and Ease of Use
- Automatic Diversification: TDFs provide instant diversification across a mix of asset classes (stocks, bonds, and other investments), with a glidepath of lowering risk allocation automatically as the target (retirement) date approaches. This “set it and forget it” approach simplifies investing for individuals lacking the time, expertise, or interest to manage their investment portfolios actively.
- Decision-Making: TDFs require minimal decision-making from investors. An investor only needs to choose a fund or automatically default into one with a target retirement date closest to their expected retirement year. However, this is not personalized, as the assumptions made in managing the portfolio are based on national worker averages. This contrasts sharply with managed accounts, which require ongoing updating of personal and financial information to personalize portfolio allocations
- Cost-Effectiveness
- Lower Fees: TDFs generally have lower management fees than managed account services. Managed accounts often include additional fees for personalized advice and portfolio management, which can reduce investment returns over time.
- Economies of Scale: Pooled investment vehicles such as Collective Investment Trusts (CITs) benefit from economies of scale, which help reduce organizational and compliance costs and expenses.
- Risk Management
- Built-in Glide Path: A TDF’s glide path automatically adjusts the portfolio’s risk level as the investor nears retirement, shifting from aggressive to more conservative investments. This built-in risk management strategy helps protect the investor’s capital as they approach the point when they’ll need to start withdrawing funds.
- Consistency: Managed accounts’ risk management can vary widely depending on the service provider and the individual’s specific circumstances. Not all managed account portfolio construction methodologies are the same, and how each manages portfolio risk may vary widely.
- Regulatory Support and Widespread Acceptance
- QDIA Status: TDFs often serve as Qualified Default Investment Alternatives (QDIAs) in retirement plans, which provides fiduciary protection to employers who offer them as default options. This safe harbor regulation encourages broader use and acceptance of TDFs in retirement plans.
- Standardization: TDFs are standardized products that are easy to compare and understand, making them an attractive option for plan sponsors and participants. Conversely, managed accounts are highly customized, making evaluation and comparison more challenging for an average investor, and typically provide no performance track record.
In summary, for the average investor or employee, TDFs offer a straightforward, cost-effective, and relatively low-maintenance way to invest for long-term investing, making them a superior choice to more complex and expensive managed accounts programs. These factors contribute to their widespread adoption and success in the retirement planning market.