Disappointing GAO Report on Target Date Funds Misses Opportunity to Improve Risk Management

Ron Surz, CEO of Target Date Solutions

The recent Government Accountability Office (GAO) report disappoints by rubber-stamping current target date fund (TDF) practices. This report could have made a difference, but instead it puts the onus on the Department of Labor, recommending that the DOL update its TDF guidance, which the DOL has rejected.  

 I explain in the following that (1) risk near target date is very high and that (2) participants don’t want that much risk. Both of these facts should have been discussed in the report.

In April 2024 the GAO released 401(k) Retirement Plans: Department of Labor Should Update Guidance on Target Date Funds in response to a May 2021 request from Senator Patty Murray (D-WA), Chair of the Health, Education, Labor, and Pensions (HELP) Committee, and Rep. Bobby Scott (D-VA), Chair of the House Education and Labor Committee.

The May 2021 request specifically asks the GAO to report on the risk in Target Date Funds (TDFs) and to explain why the Federal Thrift Savings Plan’s (TSP’s)  TDFs are so much safer at their target date. But rather than opining on TDF risk, the GAO  report  rubber stamps current practice. This is disappointing because TDF risk is very high at the target date. The GAO should have addressed this problem but doesn’t.

Congresspersons Murray and Scott wrote:

“…we write to request the Government Accountability Office (GAO) conduct a review of target-date funds (TDFs). The employer-provided retirement system must effectively serve its participants and retirees, and we are concerned certain aspects of TDFs may be placing them at risk.

…According to The New York Times “many of the major target-date-funds  tailored for people retiring in 2020, for example, have 50 to 55 percent of their investments in stock funds….Meanwhile, the Thrift Savings Plan 2020 Lifecycle Fund had more than 60% allocated to the G Fund (short term U.S. Treasury securities) for the two years prior to its retirement.“

The GAO report was 3 years in the making. At $4 trillion and growing, TDFs are very important. Yet, the GAO report fails to meet its potential to improve the industry, especially risk at the target date.

Using information from the GAO report, I explain in the following that risk near target date is very high and that participants  don’t want that much risk.

Risk near the target date is much higher than it should be.

How do you know the “right” level of risk for those near retirement? This is a question that has been addressed extensively by academics, and their answer is “very safe.” Most TDFs say they follow academic theory, but they don’t. The TSP’s L Funds (which are the TSP’s TDFs) are a notable exception – they do follow academic theory, so they’re very safe at the target date.

  As requested, the GAO contrasts the risk of the TSP to that of the TDF industry, as shown in the following 2 graphs. TDFs say they follow academic lifetime investment theory but most do not follow the theory as explained in this article. The theory is 80% risk-free at the target date, but the industry is 90% risky throughout (at all ages) in risky equities and long-term bonds.

The TSP does follow the theory. It is very safe at the target date with 70% in the risk-free G fund guaranteed against loss by the US government.

Regulators should know that academic theory is very safe for those near retirement, and they should confront the industry to explain their claim to follow the theory. This departure from theory has been rewarded for the past 15 years because US stocks have enjoyed their longest bull market ever, but that will change. High risk will suffer high loss in the next stock market crash; that’s the nature of risk.

Congresspersons Murray and Scott expressed concern about the level of risk in TDFs. The study accepts industry risk without questioning why it is greater than the TSP and    academic theory. An important opportunity to improve TDFs should not be missed.

The GAO reports that advisors place heavy emphasis on workforce demographics in their selection process but there is only one demographic that all defaulted participants have in common – lack of financial sophistication – and that demographic makes them like our dependent children. The Duty of Care is like our responsibility to protect our young children from avoidable harm. Defaulted participants deserve and need protection.

Some say that participants don’t know what they need and want, and that they need high risk because they have not saved enough. But surveys of participants show that they do know, and they want to be protected near retirement.

Participant interests are not aligned with the interests of those who were interviewed for the study.

The GAO interviewed management companies and advisors. Both are happy with the status quo, but the current structure is not the best for participants as outlined in  DOL Final Fiduciary Rules Could Resolve Conflicting Interests in Target Date Funds.  

The GAO did not interview participants. Other surveys that interview participants  report that participants want to be protected as they enter retirement, and most believe they are protected. Defaulted participants do not choose TDFs; their fiduciaries choose for them. Also, remember that GAO employees are participants in the TSP, and that the TSP’s TDF actually follows academic theory  -- it protects.

There are three interest groups in TDFs. Investment managers create TDFs for profit, which is, after all, their business. Fiduciaries choose TDFs, presumably for the benefit of participants, but that’s not what is happening. Beneficiaries want to be protected, especially as they enter retirement, but they are actually exposed to substantial risk.

Conclusion

78 million baby boomers will spend this decade in the Retirement Risk Zone when losses can devastate the rest of life. Many are invested  in the $4 trillion TDF industry and will be significantly harmed by a crash in this decade.

More By This Author:

Coming Soon: Revenge Of The Baby Boomers
The 2022 Stock Market Crash
Whose Expected Return Is It Anyway