Having a professionally managed approach based on personalised parameters is plainly much better than the individual investor trying to do this themselves, unless we are talking about a very high-net-worth investor with adviser support.
Personal yet part of a cohort
Ignoring high-net-worth individuals, who often have significantly different risk budgets and profiles, most of us need support with our retirement investment planning.
Such support on an individual level would be prohibitively expensive, but when a cohort of people with the same objective, such as age 45 now and wanting to retire at age 67, are combined, then the problem becomes easier to manage. This is the basis on which almost all TDFs operate.
A personalised, yet collective approach also has other benefits, including:
- Providing an uplift for people with inadequate savings.
Many people will be sufficiently far away from retirement age that they should be investing in assets that have a higher risk and reward ratio. Unfortunately, if you have inadequate savings the automatic approach is to invest in less risky investments, accepting the fact that it will most likely produce a likely poorer return. However, by pooling assets such an approach can be ameliorated over multiple participants, hence on aggregate a higher return is produced. The creation of a larger pension pot also helps reduce some of the longevity risks that an individual might face.
- Asset allocation.
The recent 2020 study in the US by Mitchell and Utkus of 401k-focussed TDFs found that people using low-cost TDFs as the default fund option improved their asset allocation in several important ways. They increased their allocation to equities and bonds and decreased the allocation to company stock and cash.
TDFs a popular investment among the young
Of particular importance if we are looking to close the retirement savings gap and help support the self-employed, gig workers and auto-enrolment workers is offering products that they understand and are easy to manage.
A March 2021 study by the US Investment Company Institute and the Employee Benefit Research Institute found that 62 per cent of 401k participants in their 20s held TDFs, compared with half of 401k participants in their 60s. On average, 401k participants in their 20s held about half of their 401k plan account assets in TDFs, compared with about 23 per cent for 401k participants in their 60s.
TDFs are also used at a higher rate among recently hired plan participants. Among those with two or fewer years of tenure, 57 per cent held TDFs, compared with 54 per cent of participants with five to 10 years of tenure, and 36 per cent of participants with more than 30 years of tenure.
Charges
As you would expect, charges vary depending on the provider and the assets that they use within their TDF. As TDFs are a type of fund of funds, their structure makes them more expensive than other funds, but this must be viewed against their structural advantages in providing greater reward with lower risk. At the same time, TDFs benefit from better fees agreed by the asset manager; there are economies of scale with TDFs that might make it even more cost-effective than a DIY option.
