Target-date funds are generally considered a set-it-and-forget-it investment, but the pandemic demonstrated how severe uncertainty can impact even these back-burner investments.
“Based on a normal distribution of returns, historical data suggests a single-day decline of 12% in the equity market should almost never happen – yet it did on 16 March,” according to an investment insight from PIMCO.
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When they’re selecting investment options, especially the qualified default option, retirement plan advisors and sponsors need to consider the impact that those rare events will have on participants who are closest to retirement, according to authors Erin Browne, Bransby Whitton and Georgi Popov. Outflows from TDFs in or within five years of retirement reached nearly $12 billion in the first quarter of 2020, they wrote. Outflows from those vintages continued in the subsequent quarters, even as the economy recovered, “effectively ‘crystallizing’ their losses.”
The authors suggested three ways that advisors and sponsors can protect participants’ investments and prevent them from bailing out when markets get rough.
The authors note that understanding a glide path’s level of diversification requires a look at risks along the entire glide path. They state that well-diversified bond allocations in TDF glide paths can “enhance the yield of core bonds by anywhere from 0.5 to 1 percentage point in the current market environment.”
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“The relative performance of TDFs during the 2020 drawdown showed that advisors and sponsors should pay special attention to so-called ‘through’ glide paths for older age cohorts given the meaningfully higher equity allocations at retirement relative to ‘to’ providers,” they wrote.
Using data from Morningstar and PIMCO, the authors found that active bond managers outperformed benchmarks by between 0.64% and 1.46%. Advisors and sponsors should consider where the higher fees for active management can produce the most yield for participants. They suggest a blend of active bonds with passive equity investments.
Of course, participants need to understand how emotional decisions today will affect their outcomes in the future – especially the near future for participants close to retirement.
The authors offered best practices for communications that will have a positive impact on participants’ behaviors.
Related:
How ‘Zero Bias’ in TDF Selection Hurts 401k Performance
Why Creating Income Solutions in Target Date Funds is So Important
Few 401k Plans Currently Offer Alternatives Within TDFs