Satisfy DOL guidelines with a participant-focused approach to evaluating target date funds.
Wesley Phoa, portfolio manager, target date and fixed-income funds, 21 years of experience.
Jason Bortz, ERISA attorney, 17 years of experience.
Toni Brown, CFA senior defined contribution specialist, 25 years of experience.
John Doyle, senior defined contribution specialist, 28 years of experience.
Rich Lang, investment specialist, 21 years of experience.
Target date funds have enormous potential to make defined contribution plans more effective and straightforward for participants. But to capture the funds’ benefits — and to help meet fiduciary obligations — plan sponsors must implement thorough, well-documented evaluation procedures.
The U.S. Department of Labor has made it clear that plan sponsors must carefully evaluate target date series before adding them to a plan’s investment lineup, periodically re-evaluate any target date funds currently offered by the plan and document the process.1 Yet evaluating and understanding target date funds can present challenges to plan sponsors. Although the funds are designed to make retirement investing simple and convenient for plan participants, their underlying construction can be complex and can vary widely among the dozens of series on the market.
We believe that plan sponsors’ evaluation process should encompass the following five considerations:
Glide Path Construction
Cost Versus Value
Quality of Underlying Funds
Consistency and Repeatability
In this series of five articles, we walk plan sponsors, consultants and retirement plan advisors through each of the five components of the evaluation process. Thorough, effective target date fund evaluation will help plan sponsors fulfill not only the letter of the fiduciary rules, but also their intent: to give participants the best opportunity to meet their retirement saving and investing needs.
Consideration 3: Cost Versus Value
Plan sponsors have a fiduciary responsibility to ensure that their participants are not overpaying for the investments in the plan. There is a tremendous range in fees among the target date funds on the market (see the Expense Ratios for Target Date Series chart below.) Likewise, fees may vary significantly between different share classes. When considering any fund series, plan sponsors must understand where it falls on the fee spectrum.
Fees alone don’t tell the whole story, however. Plan sponsors and other stakeholders should consider the value a given series has provided to participants relative to its fees. If one fund’s fees exceed another’s by 10 basis points, but the fund has consistently provided a 30-basis-point advantage in annualized returns, participants may be better served by the slightly more expensive option.
Plan sponsors can gauge value by comparing expenses with returns over rolling periods. A target date series may be relatively attractive from a value perspective if it has consistently generated excess return relative to its peers and is not commensurately more expensive. Creating a scatter graph that plots excess returns against expenses can visually demonstrate the value that fund series have provided for their costs.
Ideas for Action
- Check fees against other target date series
- Check fees of different share classes
- Graph fund series’ excess return against expenses for a visual demonstration of value