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Are target risk funds appropriate for 401k plans? I don’t think so. Here’s why:

What are Target Risk Funds?

Target risk funds (sometimes called risk-based or lifestyle funds) are professionally managed, diversified investment options that target a 401k plan participant’s risk level. Each participant must determine which target risk fund is appropriate to invest in by taking a risk assessment quiz. Quiz results determine an individual’s ability to bear risk (e.g.; conservative, moderate or aggressive). This is different from target date funds, where a participant’s correct target date fund option is determined by the date he/she will turn age 65.

What’s Wrong With Target Risk Funds?

Plan sponsors wishing to offer a professionally managed series of investment funds should note the following problems with target risk funds that cause them to be vastly inferior to target date funds:

Participant inertia

Target date funds use plan participant inertia (the tendency of participants to set-it and forget-it) in a positive way. Once a participant invests in a target date fund, it is not necessary for him/her to make adjustments as time goes by. The opposite is true with target risk funds. Participants have to identify the various points in their lives when their risk tolerance changes and choose to move to a lower risk fund. Most 401k plan participants have a difficult time judging when their ability to bear risk changes. Many are just too busy and forget to make adjustments. This is the most significant deterrent to using target risk funds in 401k plans.

Participants take on more risk than they should

Due to participant inertia, most participants end up staying in a higher risk option for longer than they should. As a result, they end up taking more risk than they have the ability to bear.

Participants learn they are in the wrong fund at the wrong time

The absolute worst time for participants to learn they are invested in an option that is riskier than they thought is when they have suffered a loss greater than they can bear. This is a common experience for participants who have waited too long to move from a higher to lower risk fund.

Participants become dissatisfied with the plan

As a plan sponsor, you know you typically hear from participants only when they have a bad plan experience. When participants have lost more than they thought they should because they were invested in a fund that took on more risk than they were able to bear, they will complain to you.

Greater participant education responsibility

Participants need a significant amount of education to understand their ability to bear risk and the risk profiles of the target risk funds available. For many participants, the concepts of risk and risk tolerance are very difficult to understand. Also, to be safe, should you administer risk assessment quizzes each year to all participants to catch those whose risk tolerance has changed? Do you have a fiduciary obligation to do so? Quizzing employees annually could become tiresome. None of this type of participant education is required when using target date funds.

Target-risk funds can be difficult to evaluate

Since many target risk funds are comprised of the core fund options offered in a 401k plan, they end up being unique investment options that are difficult to evaluate. What is the appropriate benchmark for a moderately aggressive target-risk option comprised of your unique menu of core funds? Target date funds don’t suffer from these benchmark/evaluation issues.

As a result of these deficiencies, most plan sponsors use target date rather than target risk funds as their professionally managed QDIA compliant investment option. If you are currently using target risk funds in your 401k plan, talk to your investment adviser about whether that approach is still appropriate.


About the Author

Robert C. Lawton, AIF, CRPS is the founder and President of Lawton Retirement Plan Consultants, LLC. Mr. Lawton has over 30 years of retirement plan consulting and administration experience and has provided consulting services to many Fortune 500 companies including: Aon Hewitt, Apple Inc., AT&T, First Interstate Bank, Florida Power & Light, General Dynamics, Houghton Mifflin Harcourt, IBM, John Deere, Mazda Motor Car Company, Northwestern Mutual, Northern Trust Company, Trek Bikes, Tribune Company, Underwriters Labs and many others. Mr. Lawton may be contacted at (414) 828-4015 or

About Lawton Retirement Plan Consultants, LLC

Lawton Retirement Plan Consultants, LLC is a Milwaukee, Wisconsin-based independent, objective Registered Investment Advisory (RIA) firm providing investment advisory, fiduciary compliance, employee education, vendor management and plan design services to 401(k) plan sponsors. The firm currently has contracts in place to provide consulting services on more than $400 million in plan assets. For more information, please contact Robert C. Lawton at (414) 828-4015 or or visit the firm’s website at: Lawton Retirement Plan Consultants, LLC is a Wisconsin Registered Investment Adviser.

Important Disclosures

This information was developed as a general guide to educate plan sponsors and is not intended as authoritative guidance, tax, legal or investment advice. Each plan has unique requirements and you should consult your attorney or tax adviser for guidance on your specific situation. In no way does Lawton Retirement Plan Consultants, LLC assure that, by using the information provided, plan sponsor will be in compliance with ERISA regulations. Investors should carefully consider investment objectives, risks, charges and expenses. The statements in this publication are the opinions and beliefs of the commentator expressed when the commentary was made and are not intended to represent that person’s opinions and beliefs at any other time. The commentary does not necessarily reflect the opinion of Lawton Retirement Plan Consultants, LLC and should not be construed as recommendations or investment advice. Lawton Retirement Plan Consultants, LLC offers no tax, legal or accounting advice and any advice contained herein is not specific to any individual, entity or retirement plan, but rather general in nature and, therefore, should not be relied upon for specific investment situations. Lawton Retirement Plan Consultants, LLC is a Wisconsin Registered Investment Adviser and accepts clients outside of Wisconsin based upon applicable state registration regulations and the “de minimus” exception.