“Every time you date someone with an issue that you have to ignore, you’re settling.” -Andre Breton (French writer & poet)
As I’m now solidly into the “middle ages” of life, I can date myself (pun intended) by talking about the old days, when meeting people still largely occurred in person. In what has been one of the most significant evolutions of mankind (for better or worse), people now often meet “on the apps.” Case in point: dating apps generated $6.18 billion in revenue in 2024, driven by over 350 million users, in yet another example of technology creating a new market.
And while people now often meet on platforms like Tinder, Bumble, and Hinge, this ideally leads to an in-person meeting, such as an old-school dinner date. Thus, dating apps are just a more efficient means of garnering warm introductions vs. being set up on blind dates by friends, like we did back in the 1900s and early 2000s. By casting a wider net and applying some initial screening, we can hopefully improve the success rate of the dates, themselves (I can imagine some pretty subjective measures of “success,” here).
[This has me wondering how much restaurant business is the result of in-person dates from apps, but I digress…]
Speaking of more targeted dating, today, we’ll continue learning more about target-date funds so we can approach them with eyes wide open. In Part 1, we discussed some of the general assumptions embedded within these investments, as they are built for mass appeal. To the point of today’s quote, rather than ignoring issues and settling for potentially inappropriate relationships with our retirement plan options, let’s seek greater understanding to see if we can tailor them more to our individual needs. Here we go!
Active, Index, Blends
All target-date funds are not created equal, and one clear way to illustrate differences between them is via their underlying composition. Some favor active management, some favor passive (indexing) management, and some utilize a blend of active and passive approaches.
Active management implies the attempt to improve performance through putting one’s thumb on the scale in some form. For example, an active fund of large cap stocks may buy 50 companies in various weightings with the aspiration to outperform (i.e., less volatility, more return, higher income, all of the above) vs. a given index benchmark like the S&P 500. But it doesn’t have to be done at the company level, as it could instead be managed in other ways. “Sector rotation” is a popular example of this, where a manager attempts to give more weight to the market sector(s) they believe will generate the best forward returns, and then adjust (rotate) that exposure over time as conditions change.
Passive management, on the other hand, is assumed to use broader indexes for exposure – like the well-known “60/40” mix of stocks and bonds, which has often been a mix of 60% S&P 500 and 40% Aggregate Bond Index to build a portfolio. More broadly, one could shift those to global indices for an even broader “passive” exposure to global markets.
Blended target-date funds (you guessed it!) use a combination of Active and Passive approaches, and this can happen in multiple ways.
What’s Passive is Active
Not to be too nitpicky (does saying that mean I’m automatically doomed to follow this with a nitpicky statement?), virtually any portfolio construction decision is going to be a form of actively steering exposure in one direction or another. Short of owning every asset across the world in its true relative weight to global markets, an active decision is being made – primarily actively ignoring a lot of potential exposures.
With investment portfolios consisting primarily of public companies (as they do for most investors outside massive institutional investors), we’re already forgoing significant exposure to very large private markets (equity, credit, real estate), as well as currencies, etc. As we narrow the focus of portfolio components, the distinction between active and passive becomes much clearer. For example, as a true passive example, I can use an S&P 500 Index that will move in tandem with that index. Alternatively, I could use an active fund that invests in a subset of S&P 500 companies with the aspiration to beat it, where the performance can vary greatly from the index.
But, then once I take my passive “500 Index,” pair it with a bond index, and call it my portfolio, I’ve inherently made an active decision to limit global exposures (other than via multinational S&P 500 companies) and also put my thumb on the scale of weighting stocks vs. bonds. I am not saying this is right or wrong but rather that these decisions are going to have significant risk/return implications over time and are, therefore, active.
What are you made of?
In my experience, a given retirement plan typically only has one suite of target-date funds available, so you may not have a lot of choice to tweak your exposures between active, passive, and blends, but you can at least know what to look for. These will almost certainly come in the form of a “fund of funds,” meaning the target date funds will be comprised of a number of underlying mutual funds or ETFs, rather than just one big bucket of many individual stocks and bond holdings (I’ve never seen it done another way, but please let me know if you find an example of this).
Active Options: The underlying holdings will be mutual funds, often with names like “Large Cap Growth…Small Cap Value…Emerging Markets,” etc. Those underlying funds may or may not all be managed by the same fund manager as the target date fund, and if a mix of investment companies is used to populate the funds, then perhaps someone is really trying to drive outperformance; after all, no single “investment shop” is best at every asset class.
Passive Options: The underlying holdings will probably be ETFs (exchange-traded funds), but technically could also be Index mutual funds. In either case, those ETFs or mutual funds will include “index” in the name, such as an “S&P 500 Index Fund.”
Blended Options: You’ve probably already figured this out, but this is a blend of the above two options, based on the manager’s perspective on which asset classes make more sense to access using active or passive strategies. Again, if a manager is taking the approach of constructing a mix of active and passive strategies, at least it seems like they are trying to build a better solution (to say nothing of actual results).
Since the Active approach will tend to be more expensive, and defined contribution plan (e.g., 401(k), 403(b) plans) fund selection is increasingly a game of providers needing to cover themselves legally (CYA is the technical term) because of lawsuits, expect a bias toward passive/index target-date funds in your plan. It is easier to defend opting for lower-cost options, and no one– including boards, advisors, or plan sponsors – wants to stick their neck out unnecessarily. When it’s easy to find articles like How Not to Get Sued in 2026: Part 1, regarding 401k plans, you can see why.
Now look under the hood
With the understanding of the above, it will be pretty easy to see what options you are being provided with. Beyond that, ensure that you are comfortable with the allocation mix of the fund you choose (not only stocks vs. bonds, but also domestic, international, and emerging markets)…or ask your trusted advisor for their thoughts.
Alts and out
There is a lot of debate regarding the addition of true alternative options (like private market funds) to retirement plans, but as CAIA nicely sums it up, it is unknown “whether defined contribution plans are structurally equipped to handle illiquidity, complexity, and risk at scale…as well as how global pension models, governance trade-offs, and participant behavior complicate the debate.” If fees or not choosing the lowest-cost fund options are already leading to lawsuits, then what can of worms would expensive, illiquid Alts open? You can bet asset managers would love to tap into this massive pool of capital, but it’s a topic we’ll target for another date (😊), as it evolves.
Until next time, this is the end of alt.Blend.
Thanks for reading,
Steve
