Should you rely on target-date funds for your retirement?
Pick a fund and you’re done. For many investors investing for retirement, the simplicity of putting their money in a product that does everything for them is enticing. Hence the popularity of target-date funds (TDF). It’s like a one-stop shop for retirement planning.
What are they?
I write a lot about the need to set up a well-diversified portfolio of both stocks and bonds and keep it current with your current stage in life. When you are younger and have more time until you retire, you can afford, statistically, to be growth oriented in your investment strategy. If you are nearing retirement age, chances are that you will need to have a much more conservative portfolio that will generate the income you need to live off of.
TDFs work like this: First, you pick a fund with a date that matches your approximate retirement age. For example, if you are 30 years old and you plan to retire at 65, you pick a target date of 2050. It’s important to note that the funds come with dates that have increments of five years. The fund manager invests your money in a well-diversified portfolio of bonds and stocks according to various mathematical models on how exactly one should diversify. As you get closer and closer to retirement the fund is theoretically supposed to become much more conservative.
It does the work for you
I would say that the best feature these funds offer is that they automatically update and reallocate your portfolio as you get older. Whatever asset mix the fund starts out with, it automatically shifts money from stocks into bonds and cash over time so that the portfolio becomes more conservative and less volatile as you move toward retirement.
By the time you retire, the fund is mostly invested in bonds and cash with a modest stock position to provide some long-term growth. The benefit to you, the investor, is that you don’t have to do anything: You have a one-stop, well-diversified portfolio that is constantly being updated. You can concentrate on your family or your work and not have to give a second thought if you are investing properly.
Whatever asset mix the fund starts out with, it automatically shifts money from stocks into bonds and cash over time
What are the advantages?
These mutual funds provide two very important services for investors. One is that they provide a hassle- and timefree way to save for your retirement while providing you the confidence that your money is being invested in a long-term investment vehicle that fits your personal time horizon. The second reason, more cynical but no less important, is that these funds help save investors from themselves. Investors often hear a tip form someone or have their own good idea and feel compelled to act on them, even though it will have adverse effects on their overall portfolio. The beauty is that because it is a managed fund, this issue will not arise.
What are the disadvantages?
While at first glance these TDFs seem like a perfect investment, they continue to come under fire from many analysts for not delivering in practice what they promise.
“TDFs have come under fire for maintaining high equity allocations even in funds tailored for investors near retirement age,” Reuters reported. “Many TDF investors near retirement age suffered dramatic losses in the 2008 market crash. Target funds with dates between 2000 and 2010 lost 22.5 percent in 2008, and funds with target dates between 2011 and 2015 lost 28 percent, according to Morningstar. But those are broad averages; some funds with dates as early as 2010 lost as much as 50 percent of their value in 2008.”
This is obviously not what someone about to retire had in mind when he made this investment. As such, these same analysts believe investors doing retirement planning either work with an adviser or a fee-based financial planner to personalize a retirement plan that better suits the specific profile of the individual investor. That they are not personalized is a problem for many investors. Not all investors have the same goals or needs and are in the same financial situation. They require a specifically tailored approach, not a one-size-fits-all approach.
Therefore, before deciding on whether TDFs are appropriate for you, speak with a financial professional to work through all the pluses and minuses.
The information contained in this article reflects the opinion of the author and not necessarily the opinion of Portfolio Resources Group, Inc., or its affiliates.