Is the target-date fund revolution leading retirement plan participants down the wrong savings path? 

A new paper by academics from New York University and Fordham suggests as much, saying the jury is still out on TDFs, although almost three-quarters of defined contribution plans now offer them and 41 percent of all investors have assets in them. 

The automatic rebalancing that TDFs offer as participants near retirement may not be doing enough to maximize retirement income, according to the authors. 

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Instead of TDFs, they suggest the industry take a closer look at Target Risk Funds, which establish an investment course that accounts for factors beyond a glide path, or the year in which a participant expects to retire.

TRFs, which take into account a participant's wealth, risk preferences and income needs after retirement, merit more attention from the investment and academic communities, argue Edwin Elton, Martin Gruber and Andre de Souza. 

The three set out to compare how hypothetical savers would fare under the two strategies, the first research of its kind, they claim. 

First, for those unfamiliar, a few facts about TRFs:

  • TRFs "hold risk" over time, meaning they tend to maintain the same allocation to stock and bond funds, unlike TDFs, which automatically rebalance allocations according to age. 
  • The vast majority of TRFs are "funds of funds," meaning they don't hold individual securities, but spread risk through incorporating other funds and their managers.
     
  • That also means investors in TRFs pay an added layer of fees — one to the TRF, and then fees to all of the other mutual funds held in the TRFs.
     
  • Some TRFs bear more risk than others, but they also can be more conservatively allocated than conservative TDFs. 
  • They're mostly invested in the same asset categories as TDFs, with slight differences. Commodities, for example, are held in 40 percent of TDFs, and only 27 percent of TRFs.
     
  • Of the 50 fund families studied that offer TRFs, 46 also offer TDFs, and their management teams oversee both types of funds. 

So how did the type fund types compare over years (2001-2014) the academics sampled? 

A portfolio of risk-focused TRFs recorded an annual mean return about 40 basis points higher than an equivalent portfolio of TDFs. Even when the TRFs' higher expenses were factored in, they outperformed TDFs by 33 basis points, the paper said.

The results also suggest that the funds selected by TRF managers produced returns comparable to mutual fund averages, suggesting the fund-picking instincts of the managers, and the fees paid for them, offered little added value. 

Nonetheless, the paper concludes TRFs are a "reasonable alternative to target date funds for pension plans and individuals."

So there you have it; now let the TDF-TRF debate begin. 

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Nick Thornton

Nick Thornton is a financial writer covering retirement and health care issues for BenefitsPRO and ALM Media. He greatly enjoys learning from the vast minds in the legal, academic, advisory and money management communities when covering the retirement space. He's also written on international marketing trends, financial institution risk management, defense and energy issues, the restaurant industry in New York City, surfing, cigars, rum, travel, and fishing. When not writing, he's pushing into some land or water.