Just when plan sponsors thought they’d finally gotten a handle on the proper investment strategy for target-date funds, along comes some new data from Morningstar that contradicts long-standing assumptions about participant contributions. As a result, plan sponsors may want to rethink their approach to these funds’ glide path, or asset allocation, once again.
In theory, employees choose a target-date fund based on the year they plan to retire and put money into the fund until that date. Then the contributions stop. (Whether investors actually withdraw their assets at retirement, and how quickly, is a different debate.)
However, when Morningstar analyzed the net inflows of all target-date providers for its newest annual survey, it found that the amount of money going into funds targeted for 2005 and 2010 actually increased after the official expiration years. In fact, for the 2005 funds, the inflows jumped significantly after 2005, with the 2007 total ($1.14 billion) nearly twice as high as in 2004 ($593 million).
The obvious answer – that people are not retiring at their original target date – explains only part of the data. “People may have optimistically anticipated what their retirement age was going to be, and then they work beyond that,” says Josh Charlson, a senior mutual fund analyst at Morningstar, who admits that he was “somewhat surprised” by the findings. Certainly, it’s well established that workers are postponing retirement, especially in the current tough economy. In 2010, 17.4 percent of people over age 65 were in the labor force, up from 10.8 percent in 1985, according to the Sloan Center on Aging & Work at Boston College.
Moreover, target-date funds are available only in increments of five or 10 years. So someone who always intended to retire in 2008 might well have a 2005 fund but keep working – and contributing -- until 2008.
Still, that explains only the fact that contributions are continuing. It doesn’t explain the increase in the size of the contributions. That’s especially puzzling because most contributions are automatically deducted from paychecks, making it tough to change the amount.
Charlson suggests that as participants delay their retirement, “there may be a certain amount of catch-up contributions being made.” People may say, “Let’s get as much as we can into a tax-deferred account while we can.”
In light of this unexpected pattern, Charlson says that plan sponsors should seek out a target-date fund series with a glide path “that looks to keep a higher equity weighting relatively speaking, that isn’t getting completely conservative at the target date.” If people aren’t, in fact, retiring at the target date, then the fund “needs to keep managing the assets for a longer period.”
But that advice directly contradicts the newest trend in plan sponsor target-date management, a trend toward more caution.
After the 2008 market collapse, participants and politicians protested that the glide paths were too aggressive, holding too much in equities at the supposed retirement date. So, managers have recently been dialing back on risk and putting in inflation hedges and income-oriented investments. “There’s a common theme: Is there a way to enhance diversification through improving returns and reducing expected volatility?” says Jerome Clark, the T. Rowe Price portfolio manager who oversees these funds.
Now what should a plan sponsor do?
“I think there was an element of overreaction to the 2008 market,” Charlson says. “Plan sponsors should make sure that the target-date funds they are using are matching up with the behavior of their investors.”
