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Low-cost target date index funds will fundamentally reshape the market for small business retirement plans – and soon!

Greg Carpenter

December 29, 2022


My blog headline is not a bold prediction. It is a cold hard fact of the market. The train has left the station. The genie is out of the bottle. Elvis HAS left the building.

Quick recap. Target date funds adjust the asset allocation between equities and fixed income investments over time as the “target date” for retirement nears. As investors get closer to retirement, the percentage of assets in equities is reduced, to decrease volatility. Indexed investments are… you know this already if you are reading my blog!

Here’s the analysis.

Target date index funds (TDIFs) are universally available. TDIFs are cheap to own and trade. There are few or no restrictions on redemptions. Trading costs for mutual funds within retirement plans are literally pennies per trade.

As I write this, any, repeat ANY plan sponsor in the USA may have TDIFs in the company retirement plan, regardless of the number of employees in the plan or the total value of plan assets. Plan providers may not allow the addition of TDIFs, but that is an artificial restriction set by the provider based on its business model. If you want TDIFs, but can’t get them with your current provider, check out my blog on shopping your plan.

TDIFs represent a baseline investment strategy. I’m not saying you can’t do better than TDIF returns – I’m saying you should never do worse than the returns you can get from TDIFs. Period. With TDIFs you are guaranteed to achieve market returns, less the small management fee. I’m not averse to active management, but if you are a sponsor of a small business retirement plan, TDIFs are a low cost vehicle for getting your employee’s money into the market with the least amount of drag. TDIFs provide a solid core strategy well matched to long-term buy and hold investing. Why gamble when you can buy the market?

TDIFs change the fundamentals of value added for investment advisors. Pop quiz: How do advisors add value? If you said “beat the market” take a nickel out of petty cash. But most don’t ever beat the market because the fees they charge put the whole proposition under water. With TDIFs, the advisor stops trying to beat the market, and instead focuses on increasing participation, increasing deferral rates and helping employees transition to retirement. Hundreds (thousands?) have already adopted this model and are working to help people get ready for retirement. TDIFs will accelerate the trend.

TDIFs change the responsibilities for both employees and the employer – for the better. As an employer, my objective is to incentivize my employees to save and be ready for retirement. I’m pleased to pay for the administrative costs of the plan, but I believe the employees should pay the freight for the expense ratio of the funds they select. With TDIFs as a core investment option, I am giving all employees access to the market with maximum flexibility and minimum drag. As an employer, I have done the best I can for my employees.

What about investment advice? Current practice is for the employer to hire an advisor and spread that cost over all employee accounts regardless of whether the employee actually utilizes the advisor’s services. With TDIFs, the nature of advice changes – and so does the way it is purchased. Advice is “unbundled” from the investments. Employers get out of the advice business and employees are free to engage advisors as they choose. By design, services are tailored to the individual needs of the employees.

Outlook for small business retirement plans

The changes described above contribute to making the 401(k) plan a true retirement savings vehicle. The drag on earnings is significantly reduced. Asset allocations are better matched to employee needs. Advice is geared to the individual. And fees? Rock bottom.

The most important point is that any plan – regardless of size – can achieve these results. TDIFs level the playing field.

How long until these changes dominate the industry? My money is in a 2020 TDIF.

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