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Why Using Target-Date Funds as a QDIA Is Outdated

A look at how investment options have evolved for plan sponsors

Will managed accounts make it nearly obsolete to use target-date funds as a qualified default investment alternative, or QDIA? Probably. But will this pivot happen anytime soon? Probably not.

I think it’s a worthwhile exercise to go back to 2006. Many notable things happened in 2006, including the ability to buy full-length movies and watch them on your 2.5” iPod screen. But the passage of the Pension Protection Act was also notable. This law designates these three investment options as suitable for a plan sponsor to use as a QDIA: a balanced fund, a target-date fund, and a retirement managed accounts program.

3 reasons many plan sponsors considered choosing a target-date fund as a QDIA in 2006

If I was a plan sponsor picking a QDIA in 2006, it is likely I would have chosen a target-date fund out of the above three options. Why? Here are three reasons:

  1. It’s was a more personalized investment solution. Target-date funds were similar in price to balanced funds, but they offered diversification and a glide path. These features allowed younger participants to take more equity risk and older participants to take less equity risk. This meant that for the same cost, you could have a more personalized investment solution.
  2. Managed accounts were in their infancy. At the time, most offerings of managed accounts were expensive and weren’t very customized.
  3. Many plan providers struggled to send any details on participants. Plan providers often could only provide age and balance to a managed accounts provider. That meant that unless participants engaged in the managed accounts service, they essentially got an expensive target-date fund.

3 reasons many plan sponsors are considering managed accounts as a QDIA today

Times have changed for many plan sponsors, and investment options have evolved. Here are three reasons why many plan sponsors are reconsidering managed accounts as a QDIA:

  1. It’s an even more personalized investment solution than a target-date fund. The use of participant specific data including: salary, balance, contribution, age, gender, state of residence, plan rules (such as employer contributions, matching, profit sharing, etc.), pension data, brokerage holdings, or company stock can create a more personalized solution.

  2. Technical integrations between recordkeepers, payroll partners and managed account providers now exist. Without any interaction on behalf of the plan participant, a retirement managed accounts provider can receive a large amount of participant specific data (typically everything listed above) automatically.

  3. Cheaper prices. As retirement managed accounts have matured, prices have generally become less expensive. One result is a much more viable QDIA for many plan sponsors.

Considering both options for your plan’s QDIA

So, what does this all boil down to? If I’m a plan sponsor picking a QDIA today, I have a tougher decision than in year’s past. Managed accounts have become a viable QDIA for more plans, and target-date funds are beginning to look very dated to some.

Does that mean a managed accounts program is always the right QDIA? Certainly not. It might not be right for the company, it may be too expensive, or maybe some recordkeepers don’t have the necessary technology integrations. But, it’s certainly an option for plan sponsors to consider.

Dan Bruns is a product and investment specialist for the Morningstar Retirement Solutions product group.

Please see below for important disclosure.

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Morningstar Investment Management LLC is a registered investment adviser and subsidiary of Morningstar, Inc. The Morningstar name and logo are registered marks of Morningstar, Inc. Opinions expressed are as of the date indicated; such opinions are subject to change without notice. Morningstar Investment Management and its affiliates shall not be responsible for any trading decisions, damages, or other losses resulting from, or related to, the information, data, analyses or opinions or their use. This commentary is for informational purposes only. The information data, analyses, and opinions presented herein do not constitute investment advice, are provided solely for informational purposes and therefore are not an offer to buy or sell a security. Before making any investment decision, please consider consulting a financial or tax professional regarding your unique situation.