Yet, a recent LIMRA survey shows that many investors don’t understand their products. That provides an attractive opportunity for advisors to strengthen their relationships with clients by helping explain the products.
As their name implies, target date funds maintain asset allocations that are adjusted as specified target dates, which are often retirement dates, approach. The idea is to make the allocation more conservative over time to reflect investors’ shorter investment horizon and decreasing risk tolerance.
Over the years, the autopilot funds have surged in popularity. LIMRA reports that in 2010, seven out of ten 401(k) plans offered the funds and, as of the third quarter of 2012, the products held $466 billion in assets. Furthermore, an impressive 36% of plan participants had invested in the products. Going forward, LIMRA estimates that 80% of defined contribution assets will be held in the funds by 2020.
Because many 401(k) investors don’t fully understand how to use the products, advisors have a big opportunity to capture new clients and strengthen relationships with existing clients by helping them avoid potential pitfalls that can result from common misconceptions about the funds.
Even though 36% of plan participants have invested in the funds, only 16% of LIMRA survey respondents said they were familiar with the products. What’s more, one in ten survey respondents mistakenly believe that the funds provide performance and principal guarantees and that the funds require shareholders to draw income when the target date is reached.
Many respondents also said they believe the funds become risk free when the target date occurs. LIMRA determined that IRA investors are also poorly informed on the products.
Some advisors, for example, have come across clients or prospects that invest in multiple target date funds within the same retirement program, which can negate the asset allocation benefits of the products. Regardless, advisors can offer to review their clients’ existing retirement plan investment strategies.
Advisors can then ask target date fund investors about their expectations for the funds and help clients ensure that the funds are appropriate for their retirement strategies. That may entail ensuring investors have selected the right target date and estimating if a fund’s and plan’s assets will generate sufficient income during retirement years.
Likewise, investors who are mistakenly expecting guaranteed income from the products may need an advisor’s assistance with determining how to generate income once the target date is reached.
Advisors, furthermore, can help investors manage risk that the funds present—especially during retirement years. While the funds become more conservative over time, all investments offer a certain amount of risk and target date funds may not invest aggressively enough to ensure that shareholders are protected from inflation. That means advisors can work closely with clients to ensure that assets in other products can generate capital appreciate that may be needed over the course of a lengthily retirement to protect against the possibility of savings being depleted prematurely.
The opportunity to educate investors isn’t limited to advisors’ existing clients. Indeed, when meeting with a prospective client, advisors can ask about an individual’s use of target date funds. Advisors can then use their knowledge of the products and of retirement planning to ensure that their potential clients don’t have unrealistic expectations for target date funds and are using the products appropriately within their retirement savings programs.
