When it comes to 401k accounts, target date funds (TDF) have seen massive adoption in the past ten years. Over 70% of 401k plans on the market offer some form of TDF and 60% of people in their 20s use them.1 Cerulli Associates estimates that by 2019, 90 percent of new 401k contributions will go into TDFs.2
This rapid adoption isn’t surprising. In concept, a TDF is not a horrible investment for retirement when used correctly. At first glance, they look like a solid retirement strategy. Namely, they offer simplicity and a diversified allocation that becomes more conservative the closer you get to your targeted retirement date.
But take a look at the elephant in the room when it comes to target date funds. They can be built with 100% proprietary funds, often from the same institution providing the 401k plan to the participant!
That seems a little like the fox guarding the chicken coop, doesn’t it?
Vanguard is the current market share leader, managing $224.9 billion in TDFs. They are followed by Fidelity and T. Rowe Price (as of 12/31/16, according to Morningstar Inc.’s annual Target-Date Fund Landscape report). These three firms manage more than 71% of all TDF assets, effectively controlling the industry.
We can’t deny the simplicity of a TDF. Unfortunately, you often end up paying for that simplicity in the form of the higher internal fees associated with these proprietary funds.
A Target Date Fund Case Study: Walmart’s 401k plan
For an example, let’s take a look at Walmart’s 401k plan. With 1.5 million 401k participants and $22 billion in plan assets, it is one of the country’s largest retirement plans. Given this size, Walmart can negotiate extremely low fund costs for its associates. The TDF options within their plan have internal expenses of 0.34%. That is roughly 50% of the industry average 0.71%. This makes Walmart’s plan one of the best-case scenarios for TDFs when it comes to expense.
Yet even in this “best-case scenario” of comparatively low expense ratios, a Walmart employee can do better.