A Balanced Fund or a TDF?

The asset growth in balanced funds has more than doubled, while the total in target-date funds (TDFs) has increased 13-fold in the 15 years since the Pension Protection Act (PPA) created qualified default investment alternatives (QDIAs).

This imbalance is not surprising to many in the industry, given the perceived advantages of TDFs. Still, with so many participants saving for a retirement date more than 10 years into the future, advisers and sponsors might consider whether the funds provide the best solution for all participants.

“Choosing a QDIA is really a big decision, potentially the biggest one that a plan sponsor committee can make, so you want to make sure you’re doing all your homework and gathering all the facts before you make it,” says Kevin Roloff, director of research at Francis Investment Counsel in Pewaukee, Wisconsin.

It is also of paramount importance to monitor the results of this decision, says Roloff. In the paper “The Unintended Consequences of Investing for the Long Run: Evidence From Target-Date Funds,” academics say managers of TDFs may even benefit from investors’ set-it-and-forget-it mentality, which prevents them from adequately scrutinizing poorly performing funds.

Of course, many TDFs are living up to their performance goals, frequently by embracing high levels of risk for participants with longer time horizons. The same can be said of TDFs with closer retirement dates. These often take more risk than novice investors expect, leading to strong performance during bull markets but raising important questions about what might happen during the next downturn. Balanced funds, given their increased simplicity, even compared with target-date funds, are less prone to such issues.

Advisers concede that there are certain circumstances in which a balanced fund might be a better QDIA selection for a sponsor than would a TDF. For instance, balanced funds might make sense for employers with a less diverse employee base, for employees who largely have other sources of retirement income such as a pension, or for employees who understand investing and may prefer to take a more active role in their retirement saving.

“For employers with a more homogenous, affluent workforce that isn’t looking to their 401(k) as their main source of retirement income, the balanced fund might be the right choice,” says Moustapha Abounadi, head of business strategy, BNY Mellon Investor Solutions.

“In that case,” Abounadi says, “the performance point might be more pertinent and relevant, making the balanced-risk approach more appealing.”

Some sponsors might work with a fiduciary adviser to select passive TDFs, under the impression that these funds limit the sponsor’s potential fiduciary liability. “Yes, the investment manager has fiduciary responsibility, but so does the plan sponsor,” Roloff says. “That’s why it’s important [that they] not rely solely on the performance assessment from the provider and instead seek an evaluation of that provider by an expert adviser.”