Why Target Date Funds Are a Breach of Fiduciary Responsibility—and Why Some Still Don’t See It

Jim Kaffen

Thu Oct 24 2024

Target Date Funds (TDFs) rely on age alone to determine asset allocation, disregarding individual financial goals and circumstances. Despite their popularity, TDFs are not a one-size-fits-all solution and may not meet fiduciary standards. A more effective approach is Target Rate Funds (TRFs), which align assets with future liabilities and provide a personalized, goal-oriented investing strategy.

In a recent poll, 89% of respondents agreed that relying solely on an investor’s age to determine a retirement strategy is a breach of fiduciary responsibility. Yet, 11% of respondents indicated they didn’t believe this practice constitutes a breach. This divergence in opinion raises a critical question: Why, in an industry that demands tailored advice, do some still defend a one-size-fits-all approach like Target Date Funds (TDFs)?

The Flawed Logic Behind Target Date Funds

Target Date Funds dominate the retirement landscape. The premise behind TDFs is straightforward: as investors approach retirement, their portfolios automatically shift from aggressive to conservative asset allocations, based solely on their age. At first glance, this glide path seems logical, but it misses the mark on what is truly essential—aligning investments with individual financial goals.

The core issue with TDFs is that they rely on a single, impersonal factor—age—rather than taking into account the unique needs and circumstances of each investor. Retirement planning, or any financial planning for that matter, requires a much more nuanced approach than simply adjusting based on age. Different individuals may have varying liabilities, income sources, and retirement goals, yet TDFs fail to incorporate these key factors.

Why the Industry Refuses to Change

So why does the investment industry cling to TDFs when it is clear that they don’t meet the needs of many investors? The answer lies in familiarity and simplicity. TDFs are easy to understand, implement, and sell. For advisors, they provide a convenient, pre-packaged solution that removes the need for deeper analysis of individual client needs. But this convenience comes at the cost of delivering suboptimal outcomes.

This situation echoes the sentiment in Frank Sortino’s article, “What Sells Doesn’t Work and What Works Doesn’t Sell.” TDFs sell well because they are simple and familiar, but they don’t actually work in the best interest of investors when it comes to personalizing retirement plans. As Sortino points out, the solutions that are truly effective often don’t get the attention they deserve because they require more effort and understanding.

Moreover, the inertia in the financial industry is staggering. Once a product like TDFs becomes widely accepted, it creates a status quo that is difficult to disrupt. Change requires a significant shift in mindset, and many are unwilling to question a product that has become so entrenched in the market.

The 11%: A Misguided Defense of TDFs

The 11% who believe TDFs do not breach fiduciary responsibility likely fall into the trap of defending a familiar product that has been the industry standard for years. It’s understandable to want to trust a product that has been sold as a safe, all-purpose solution. However, this thinking is flawed.

By relying solely on age to determine asset allocation, TDFs disregard the complexities of an individual’s financial situation. A fiduciary’s role is to act in the best interest of their client, providing tailored advice that aligns with specific goals and needs. Age alone is not a sufficient basis for building a retirement strategy, and adhering to it risks leaving clients unprepared for retirement.

While the 11% may argue that TDFs offer a "set-it-and-forget-it" solution, this approach is fundamentally misguided. TDFs may simplify the process for advisors, but they often leave clients with portfolios that don’t reflect their personal goals or risk profiles. Failing to adapt a portfolio to the client’s evolving circumstances—whether it’s a change in income, liabilities, or market conditions—is a disservice to those relying on these funds for their retirement security.

A Better Approach: Target Rate Funds

A more effective strategy focuses on identifying the return needed on current assets to meet future liabilities. This idea is the foundation of Target Rate Funds (TRFs), which offer a more personalized approach to investing. Unlike TDFs, which rely on fixed dates and age-based allocations, TRFs adjust portfolios based on the specific return required to achieve financial goals.

TRFs are not limited to retirement planning—they can be applied to any investment goal. By focusing on aligning assets with future liabilities, investors are given a more flexible, dynamic strategy that responds to changes in both their personal circumstances and the broader market environment. This approach is not only more effective but also aligns with the fiduciary duty to provide tailored, goal-oriented advice.

Conclusion: Why TDFs Fail to Meet Fiduciary Standards

The debate over whether Target Date Funds breach fiduciary responsibility should not be a debate at all. The overwhelming majority in the recent poll (89%) agree that TDFs fall short of the fiduciary standard. The 11% who believe otherwise are holding on to a product that is easy to sell but insufficient in delivering personalized, long-term financial security.

Retirement planning requires a strategy that reflects an individual’s goals, needs, and changing circumstances. Relying on age alone as a deciding factor is a gross oversimplification and, ultimately, a breach of fiduciary responsibility. The industry must move beyond TDFs and embrace more adaptable, personalized strategies like Target Rate Funds, which ensure that clients can meet their future financial goals with confidence.