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Monday, August 29, 2016

13 simple definitions to help plan sponsors select and monitor target date funds

The U.S. Department of Labor's Employee Benefits Security Administration issued tips intended to help plan sponsors select and monitor target date funds (TDFs) in their investment lineups. These target date fund basic definitions will help plan fiduciaries navigate the Department of Labor Tips for ERISA Plan Fiduciaries.
  1. Target date funds automatically adjust their asset mix to become more conservative as an employee gets closer to his or her target retirement date.
  2. QDIA is a default investment option chosen by a plan fiduciary for participants who fail to make their own investment election. The Pension Protection Act of 2006 approved target date funds as a QDIA.
  3. Glide path refers to the target date fund’s shift in asset allocation over time. Fiduciaries should understand the target date fund’s glide path and be comfortable that it is appropriate for their participant demographics.
  4. Fiduciaries should know whether the glide path uses a “to retirement” or “through retirement” approach: To retirement reduces the equity exposure over time so it reaches its most conservative point at the target date. Through retirement reduces the equity exposure through the target date and does not reach its most conservative point until later.
  5. Fiduciaries should also be familiar with the fund’s landing point—the point at which the target date fund reaches its most conservative allocation.
  6. Fiduciaries should know whether the series uses an active strategy, whereby a manager is making specific “buy and sell” investment decisions with the goal of outperforming a benchmark index, or uses a passive strategy, whereby managers follow a “buy and hold” strategy and attempt to replicate market performance by owning the same securities, proportionally, as a benchmark index. A series could utilize both strategies.
  7. If fiduciaries have chosen an active strategy they should be aware of the tactical shifts employed in the strategy. Active managers typically use tactical shifts to change the percentage of assets held in certain investment categories so as to take advantage of opportunities to increase returns and/or reduce risk.
  8. Asset classes are groups of securities that exhibit similar characteristics. The three main asset classes are equities (stock), fixed-income (bonds), and cash. Additional asset classes that may be employed within a target date fund are: world bond, emerging markets, and/or real assets like commodities and real estate investment trusts (REITs).
  9. Risk is the probability or likelihood that an investment’s actual return will be different from the expected return. This includes the possibility of losing some or all of the original investment.
  10. Volatility refers to the relative rate at which the price of a security moves up or down. Certain investments are more volatile than others.
  11. Proprietary target date funds are pre-packaged investments comprised of the underlying mutual funds of a single investment firm.
  12. Custom target date funds are built by plan sponsors who can choose to customize the glide path, asset classes, and/or underlying mutual funds appropriate for their plan demographics.
  13. Regulatory disclosure requirements refers to the DOL requirements that participants in retirement accounts receive information about the fees and expenses associated with their plans, including target date funds. Proposed regulations are being considered that would improve the disclosures that must be made to participants, specifically about target date funds.
Read 4 Steps to Building an Optimal Retirement Plan Lineup for Participants and download the Fiduciary Checklist for Target Date Fund Decisions to learn more. If you have any questions, or would like to begin talking to a retirement plan advisor, please get in touch by calling (855) 882-9177 or e-mail us at sbs@hanys.org.

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