Sizing Up TDFs

small shoesMy previous posts have covered the key conceptual issues that need to be considered when looking at TDFs. In this post I provide a very quick overview of the advantages and disadvantages of TDFs as they stand today.

It’s generally recognized that getting employees involved in planning and saving for retirement is difficult and can be costly. Retirement planning and investment education and communication programs have also had limited success. TDFs address many of these concerns and situations, which gives them the following advantages:

  • Plan members are automatically slotted into a “one size fits all” family of balanced funds;
  • Asset mix and investment options are automatically selected and managed professionally;
  • The asset mix is automatically adjusted over time;
  • Each TDF fund is rebalanced regularly;
  • The TDF can provide better diversification if a wider range of asset classes and options are used than are otherwise available to members in the plan;
  • There is no minimum investment requirement;
  • Management fees are lower versus retail funds;
  • The members can still make use of the other investment options available and the planning tools and information provided by the sponsor and record keeper;
  • Employees can opt out of the TDF and start to manage their own investments in whole or part;
  • Employees can become more involved when it suits them (in the meantime, they will be invested in a reasonably prudent manner); and,
  • TDFs can be customized in some cases to better fit the sponsor and member needs.

TDFs do provide plan members with a convenient, diversified CAP investment portfolio where the issue of too much vs. too little risk is addressed for them. For plan members who feel intimidated by having to make investment decisions (or who are too busy or not interested) TDFs are often seen as a “set it and forget it solution” allowing them to focus on other things.

At the same time, TDFs pose challenges for the plan sponsors and administrators – that leads to a series of disadvantages that they need to consider. Specifically, some of the issues that need to be addressed in providing TDFs are:

  • Members may become reliant on the TDF and, hence, disengaged from retirement planning and investing;
  • Members often believe that TDFs include guaranteed returns or safety of capital;
  • The plan sponsor is entering a long-term relationship with a single supplier making it difficult to change if things don’t work out;
  • The Administrator is still responsibly for overseeing the TDF provider and funds;
  • There is general a lack of transparency with TDFs;
  • One family of TDFs may not be suitable for all plan members;
  • The TDF manager may use other investment funds not available in the plan, which are  not part of the SIPP. That means monitoring and overseeing the TDF program is  more difficult;
  • Managers who use only or primarily in-house funds which perform poorly or are costly may represent a conflict of interest;
  • Benchmarking and/or ranking of each TDF fund and a family of TDF funds is difficult;
  • The philosophy with respect to retirement dates (“to” or “through“ ) may not be appropriate;
  • TFDs are exposed to market volatility (a concern for retired members or close to retirement);
  • CAP Guidelines still require you to provide member education and communication, etc.
  • TDFs are often quite different – it is difficult to assess and compare fees and costs;
  • Assessing performance is complex and there is no practical recourse if the TDF underperforms;
  • There is minimal regulatory supervision or guidance with respect to TDFs; and,
  • Fiduciary responsibilities are the same or more complex with TDFs.

The increased governance and administrative burden and complexity of issues related to TDFs are significant and need to carefully examined.

A summary and conclusion on the appropriateness of TDFs will appear in the next post.