Target-date funds continue to be the default investment of choice among employer-sponsored retirement plans, but the look of those funds is starting to change. Plan sponsors, especially the bigger ones, have begun moving away from traditional pre-packaged funds and towards custom target-date funds built in-house.
Such a move can have benefits for both the employer and the workers saving for retirement, but it’s important to first understand all aspects of the custom target-date fund.
What Are Custom Target-Date Funds?
Traditional target-date funds comprise a mix of stock, bond and money market mutual funds that provide investors with a single portfolio diversified and becomes progressively more conservative as the target date nears. Custom target-date funds follow the same strategy, but here the employers can choose their own investments and create their own asset allocation strategy to suit their employees’ specific retirement objectives.
Employers can choose to go with custom target-date funds for a variety of reasons.
Better diversification – Traditional target-date funds typically include only funds from one provider and may not include some asset classes. Custom funds allow employers to choose funds from multiple providers and securities from more asset classes to best fill out their menus.
Custom glide path – Employers who feel the glide path of existing funds is either too aggressive or too conservative can customize portfolio risk levels and changes over time according to their own preferences and needs.
Customization to workforce – Target-date funds tend to follow a one-size-fits-all model. Custom funds allow employers to optimize the investments offered to fit their own workforce demographics.
Cost savings – Many target-date funds include costlier actively managed funds. They also typically tack on extra management fees on top of the underlying fund fees. A custom fund allows the employer to choose low-cost index funds to fill out its portfolio in order to save on overall management fees.
When the Department of Labor declared that employers could use target-date funds as default investment vehicles, much of the fiduciary risk was lifted from employers. Custom target-date funds have somewhat changed the fiduciary landscape.
While target-date funds have been great additions to retirement plan menus, they are complex investments and aren’t necessarily appropriate for everyone. The use of custom funds recognizes that employers are putting greater effort into seeing what’s inside these funds and finding mixes that are more appropriate to the investors (i.e. the plan participants) they’re serving. In this sense, custom funds reduce fiduciary risk.
On the other hand, developing custom investment options places more responsibility on employers to build their funds properly. Developing inadequate investment options or filling these portfolio with high cost funds may ultimately be considered not in the best interests of participants.
Should Employees Push for Custom Target-Date Funds?
Custom target-date funds tend to be offered by larger employers since they often have the resources to create a committee to oversee the plan’s investments. If custom target-date funds aren’t currently a part of the retirement plan menu of bigger plan sponsors, eligible employees should inquire about having such an option.
These funds tend to be advantageous to employees because they’re often more customized to their specific needs. Custom funds can offer greater diversification and a more risk-appropriate glide path at a potentially lower cost. In addition, they’re routinely more in line with the goals of the plan sponsor than the plan provider – an aspect that plan participants should be more comfortable while making the right investment decision.
The Bottom Line
The growing popularity and acceptance of custom target-date funds suggest that the industry is recognizing they are a better fit for both employers and participants than traditional pre-packaged target-date funds. Custom funds offer employers greater flexibility to adjust the plan’s investment choices as the company’s workforce evolves. Workers benefit from potentially lower fees and a menu of options customized to their needs. As a result, participants in retirement plans that offer custom target-date funds as an option would be wise to consider them.