Sim­ple So­lu­tions What to know about tar­get-date re­tire­ment funds

Inc. (USA) - - CONTENTS - BY KATHY KRISTOF

SANDY FRAN­CIS IS LIV­ING PROOF that in­vest­ing for re­tire­ment needn’t be com­plex. The co-owner of Colorado-based Veda Sa­lon & Spa says set-it-and­for­get-it tar­get- date funds are the cor­ner­stone of his firm’s 401( k) plan. He and most of his 180 em­ploy­ees use these re­tire­ment ac­counts to put their plan­ning on au­to­matic pi­lot.

“They have an ap­pro­pri­ate mix of in­vest­ments, they’re au­to­mat­i­cally re­bal­anced, and they’re low cost,” Fran­cis says. “If you choose that kind of fund, you don’t have to worry about any­thing.”

Over the past decade, tar­get- date funds have taken the re­tire­ment-plan­ning world by storm. These types of ac­counts hold a va­ri­ety of in­vest­ments in a mix that grad­u­ally be­comes more con­ser­va­tive as par­tic­i­pants age and get closer to their “tar­get” year—pre­sum­ably the start of re­tire­ment. Be­cause they take the most vex­ing de­ci­sions out of your hands—like how much of your port­fo­lio should be in­vested in stocks ver­sus bonds, or in­ter­na­tional ver­sus do­mes­tic as­sets—they can help you avoid costly mis­takes, from panic-sell­ing to re­turn-chas­ing.

“We hu­mans are pre­dictably ir­ra­tional,” says Al­lan Roth, founder of Wealth Logic, a fi­nan­cial-plan­ning firm based in Colorado Springs, and Veda’s re­tire­ment ad­viser. “We jump into in­vest­ments af­ter they’ve gone up, and get out of them af­ter they’ve gone down. If we’re of­fered too many in­vest­ment choices, we throw up our hands and keep our as­sets in cash.”

Tar­get- date funds are “funds of funds.” In­stead of pick­ing in­di­vid­ual stocks and bonds, they in­vest in other mu­tual funds to cre­ate a broad mix of in­vest­ments. This mix ad­justs grad­u­ally to match your in­vestor risk pro­file: For young peo­ple, it em­pha­sizes growth and takes more risk to achieve it; for those close to re­tire­ment, it’s fo­cused on safer in­vest­ments that pre­serve cap­i­tal. So when you’re just start­ing out pro­fes­sion­ally, your tar­get-date fund will in­vest pri­mar­ily in volatile but his­tor­i­cally high-re­turn as­sets, such as do­mes­tic and in­ter­na­tional stocks. Ev­ery year, as your re­tire­ment gets

nearer, an in­cre­men­tal por­tion of the port­fo­lio is shifted into his­tor­i­cally safer havens, such as bonds and cash. For in­stance, Van­guard’s Tar­get 2045, geared to those re­tir­ing three decades from now, has nearly 90 per­cent of its as­sets in stocks. The Tar­get 2020 fund, on the other hand, has more than 40 per­cent of its as­sets in bonds.

Launched in the 1990s, tar­get- date funds now ac­count for $1.3 tril­lion, or roughly one-fifth, of as­sets in de­fined­con­tri­bu­tion re­tire­ment plans, such as 401(k)s, ac­cord­ing to Sway Re­search. And they’re even more pop­u­lar at big com­pa­nies. An in­dex com­piled by Cal­lan As­so­ciates, a San Fran­cisco–based money-man­age­ment firm, in­di­cates that these funds now hold nearly 28 per­cent of all as­sets in the big de­fined- con­tri­bu­tion plans it tracks—up from just 5 per­cent in 2006.

Part of that growth is due to a 2006 rule that al­lows plan spon­sors to make tar­get funds a de­fault op­tion for em­ploy­ees who fail to make in­vest­ment elec­tions within their plan. Pre­vi­ously, if an em­ployee didn’t choose an in­vest­ment, his or her re­tire­ment con­tri­bu­tions were placed in money-mar­ket and sta­ble-value funds, which of­ten earned much less than tar­get- date funds.

Of course, tar­get- date funds might not be the best choice for your re­tire­ment. If you’re ex­cep­tion­ally rich or in­vest­ment savvy, you may be able to struc­ture a smarter port­fo­lio tax-wise. So do tar­get- date funds make sense for you? Here’s what you need to know.

( THEY’RE NOT ALL ALIKE

“Set-it-and-for­get-it” de­scribes all tar­get- date funds. But ev­ery mu­tual fund com­pany takes a dif­fer­ent ap­proach to the in­vest­ment se­lec­tion, fees, and so- called glide path, the speed and ex­tent to which the fund’s in­vest­ments be­come more con­ser­va­tive over time. Though low fees are best when ev­ery­thing else is equal, there is no con­sen­sus about the best glide path or the ideal in­vest­ment mix. And some in­vestors may be happy to pay higher fees for a fund that’s bet­ter suited to their per­sonal in­vest­ment strat­egy.

Fran­cis chose Van­guard Tar­get funds for Veda’s 401( k) at Roth’s sug­ges­tion. The ad­viser fa­vors Van­guard Tar­get funds be­cause they charge the low­est fees, while still pro­vid­ing a sim­ple but widely di­ver­si­fied mix­ture of in­vest­ments. Van­guard uses just four or five stock-in­dex or bond funds in each of its tar­get-date op­tions—but each of those in­dex funds holds lit­er­ally thou­sands of in­di­vid­ual se­cu­ri­ties in com­pa­nies of all sizes, which pro­vides a ter­rific level of di­ver­sity in a straight­for­ward pack­age, Roth says. And the fees can’t be beat, rang­ing from 0.10 to 0.16 per­cent of as­sets an­nu­ally.

The tar­get- date of­fer­ings from T. Rowe Price are more com­plex, mix­ing as many as 18 funds. They also charge more for more ac­tive man­age­ment, cost­ing in­vestors roughly 0.7 per­cent of as­sets each year. How­ever, the funds have per­formed well. T. Rowe’s 2025 tar­get fund, for ex­am­ple, earned 9.75 per­cent over the past five years, com­pared with 8.86 per­cent for the com­pa­ra­ble Van­guard fund.

Mu­tual fund gi­ant Fidelity In­vest­ments also of­fers a com­plex tar­get ac­count, fold­ing more than a dozen un­der­ly­ing funds into its Free­dom 2025 and charg­ing in­vestors nearly 0.7 per­cent of as­sets each year. It also has a less-ex­pen­sive, pas­sively man­aged op­tion with fees at 0.15 per­cent. How­ever, un­like the T. Rowe op­tion, nei­ther has per­formed as well as Van­guard’s sim­pler, pas­sively man­aged al­ter­na­tive in re­cent years.

( THEY’RE NOT FOR EV­ERY­ONE

If you save both inside and out­side of re­tire­ment ac­counts, tar­get- date funds are prob­a­bly not your best op­tion, for tax rea­sons, says Roth. He sug­gests that well­heeled in­vestors mimic the in­vest­ment mix of tar­get- date funds, but do it with a savvy as­set-lo­ca­tion strat­egy. Put as­sets that are taxed at a low rate, like stock in­dex funds, in tax­able ac­counts; put those taxed at higher rates—bonds and REITs—in your re­tire­ment ac­counts, like IRAs and 401( k)s, since they are tax- de­ferred. This can min­i­mize your tax bill and max­i­mize what you have left to spend.

But for ev­ery­one else, Roth en­dorses the sim­plest re­tire­ment op­tion. Tar­get- date funds “al­low you to har­ness the most pow­er­ful force in the uni­verse—in­er­tia,” he says. “Leav­ing your in­vest­ments alone in a low- cost fund al­lows you to avoid a lot of costly mis­takes.”

TIM­ING IS EV­ERY­THING To sim­plify your in­vest­ing, just pick the year you’ll likely re­tire—and tar­get-date funds can do the rest.

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