Retirement readiness: Learn more about target-date funds
Also called lifecycle funds or age-based funds, they are not a ‘set-and-forget’ option, says Fidelity’s Peter Walsh. Participants must set goals and save diligently
By: VIRGINIA GALT
Date: October 22,2014
The onus is increasingly on employees to make investment choices that will provide adequate retirement income – and they should start young, financial advisors say.
“It’s pretty hard to talk to a 25-year-old or a 30-year-old about retirement, but as we move forward … retirement readiness is going to become much more their responsibility. No one is going to come in and provide for them” to the extent that workplace pension plans provided for employees in the past, says Peter Walsh, institutional portfolio manager for Fidelity Canada’s lifecycle funds.
His firm serves the growing Canadian market for target-date funds – a retirement savings option available to individual investors and included in the suite of choices available to members of employer-sponsored defined contribution (DC) plans.
Target-date funds, alternatively referred to as lifecycle funds or age-based funds, structure their portfolios in accordance with the expected date of retirement – adjusting the asset mix toward more conservative investments as retirement approaches and there is less time to recover from stock market losses.
Defined benefit (DB) plans – which still account for the bulk of employer-sponsored pension plan assets in Canada – pay a predetermined monthly pension for life, with the plan sponsor assuming the risk and responsibility for delivering on that pension obligation.
Under defined contribution plans, employers and employees contribute set dollar amounts each month, but the ultimate retirement benefits for each individual plan member depend on how much has been contributed and how well those contributions have been invested.
“Fidelity is doing a lot of work around communicating, ‘What do you need in retirement,’ and how much money should you have accumulated at age 65, 66, 67 or whenever you retire?” Mr. Walsh says. And, with life expectancies increasing, there is another critical question for people not covered by defined benefit plans: “How long is it going to last?”
While many DC plan members prefer to direct their own investments, “The vast majority of us are not investment experts, … we are vulnerable to behavioral biases and judgment errors,” says Oma Sharma, a Toronto-based partner and defined contribution consulting leader at Mercer Canada Ltd.
“Target-date funds help to solve many of those challenges around investments that the majority of us face: We don’t know what to invest in, we don’t know how to build a properly diversified portfolio that includes exposure to lots of asset classes … that provide you with good risk mitigation in different types of markets and market conditions,” Ms. Sharma says.
“Target date funds do all of that,” she says. Through a formula known as a “glide path,” the fund managers tailor the asset allocation according to the age of the investors – “from higher risk investments [such as equities] when you are young and . . . have lots of time to ride out those market ups and downs . . . and into less risky investments as you get closer to retirement,” Ms. Sharma says.
It concerns Mr. Walsh that target-date funds are often pitched as “set-and-forget” options for people who do not feel comfortable making investment decisions. The plan members themselves have to articulate their own retirement income goals, even if they are counting on professional fund managers to get them there – “you can’t get to somewhere if you don’t know where you want to go …”
Ms. Sharma says all the major financial institutions in Canada have online tools that help investors calculate how much money they will need in retirement and how much they will have to put aside during their working lives. Most also offer target-date fund products designed for different age groups, from twentysomething to retirement age and beyond.
At Fidelity, “We do modeling that will say, ‘What is the minimum return to get us to that overall objective?’ Then we look at asset classes. We want to be widely diversified so we would have Canadian assets, Canadian equities, we’d have euro equities, we would have emerging markets and fixed income – making sure that we dampen down the volatility but also get the required rate of return,” Mr. Walsh says. “We know that markets are going to move, but they are not going to move in tandem, so we want to make sure that we are diversified.”
Ms. Sharma, whose firm advises pension plan sponsors, says employers should be actively engaged, as well, “in making sure the plan is as good as it can be, finding ways to improve it as they go along.”
One of the ways plan sponsors can help employees achieve their retirement goals through target-date funds is by ensuring “that the fees that are being charged on the funds are reasonable … one of the things we do as consultants is to benchmark these for our clients’ DC plans on a regular basis and make sure those fees are coming down as the plans grow, because fees can make a massive difference to overall outcomes.”
Plan sponsors can encourage employees to increase their contribution levels by pointing out that – by not contributing at the maximum level under the plan – they are missing out in matching employer contributions and leaving money on the table.
“If participation is voluntary, you are always going to lose a few people because they don’t sign up; they don’t sign up because they never get through the forms and they just cannot get their heads around it. Or early in their career, they just don’t feel that pension is a big priority for them …They start [contributing] at low levels and they never revisit it,” Ms. Sharma says.
Employers should “treat it like an ad campaign, constantly promoting the benefits of the plan whether it is low fees or free money from company matching – this should be a no-brainer to sell.”