How Target Date Funds May Be the Way
I’ve noticed a curious shift over the past few years in which more clients are coming in for planning with portfolios consisting entirely of target date funds or indexing. Since I was around when target date funds were introduced, seeing them in such a position of prominence in portfolios is jarring, especially given some of the dollar amounts involved. Also, I remember during the dot com bust when overly aggressive equity allocations in certain target date funds decimated retirement accounts.
The other main self-managed portfolio theme is indexing, further signaling that do-it-yourself investors and most retirement plan participants want easy, understandable choices that don’t cost a lot of money. If you equate any S&P 500 index fund with “the market” and the market is crushing it, then buying into that strategy is a no-brainer. In fact, our managed portfolios use S&P 500 indexing as a core holding on the equity side. For many, the general argument is that indexing is superior to active management and paying more to underperform is hardly a winning strategy. And if your target date fund is all or partly indexing, you’ve covered several bases in one option.
Sometimes, my gut reaction is to want to get out of the target funds and build something more tied to the individual’s needs and goals. Or complement an index strategy with strategic actively managed investments. But then I started thinking that maybe I’m the fool here and what investors are leaning into is a structure that lets them not have to make investment decisions.
So, if individuals are relying on target date funds and passive indexes that cover the market at a low cost to build their savings, what’s the problem? Possibly none, but plenty of variables go into building an investment portfolio and even if the overall investment allocation is appropriate, maybe some of the underlying investments are not. How many investors do a deep dive into the holdings in their target date fund? Also, not all indexes outperform all the time. For example, a report by Morningstar shows that active fixed income managers may be more likely to outperform their respective indexes and active management in foreign investments does add value.1 Finally, there are plenty of well-managed mutual funds that outperform their benchmark index and provide necessary diversification potential but finding them can be as much art as science.
There may come a time when you need to take a more thoughtful and tactical approach to your portfolio to meet different goals. When that time comes, we are ready to have a discussion not only about your portfolio, but about your personal target goals and how you want to meet them. That’s the real benefit of a planning relationship, even if we ultimately suggest you keep your target date funds or indexing strategy. Only a fool tries to fix something that isn’t broken.
Meet Kristan L. Anderson, CEBS®, CFP®
1 https://www.morningstar.com/business/insights/research/active-passive-barometer
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