With the significant reduction in defined benefit retirement plans in the United States, the burden of investing retirement portfolios has been placed on the backs of individual participants, primarily in defined contribution plans. Historically, individuals have significantly underperformed institutional investors due to a lack of time, information, and expertise in managing investments. Target-date funds (TDFs) were created in an effort to bridge the gap between professionally managed pension funds and participant directed retirement plans with the goal of increasing the likelihood that individuals could achieve their retirement income goals.
This paper will first review a brief history of TDFs, followed by a discussion of fund mechanics and their pros and cons. Finally, we will provide a review of the marketplace and likely future trends that we hope will help plan sponsors make informed decisions regarding the use of TDFs. We conclude that TDFs represent an important advance in defined contribution plan design and should be included in a plan’s menu.