You Try Hitting a Moving Target
Target date funds represent the ultimate, “leave it to the experts” choice for individual retirement plan investments. They are increasingly and overwhelmingly the default fund of choice for plan sponsors, due to their evolving asset allocation strategy that attempts to cater to every person’s retirement goal. If you really thought about it though, you’d see a flaw in the logic that one option (albeit an option that has multiple sub-options) can be appropriate for all types of investors. We are simple creatures and we frequently want simple answers to our complex questions. And that’s okay. But the more we collectively rely on these simple constructs, the more they come under scrutiny.
Target date funds have been in the news since they came into being in March 1994, as a direct response to plan sponsors acknowledging that participants needed help with designing an appropriate retirement portfolio.1 Early iterations of target date funds were designed to get participants to retirement, with very little thought of what happens once they are there. From these “to retirement” funds evolved the “through retirement” option that promises to manage your nest egg until the end of your days. If only it were that simple.
Morningstar’s John Rekenthaler highlights a new academic study on target date funds2 that makes some relatively obvious conclusions that can be summarized as follows: Target date funds are most appropriate for younger investors, and older investors need to be more engaged in the investment of their retirement funds.
If we think about being simple creatures, then our younger selves require a more simple investment solution. This is because accumulated wealth is not likely to be significant and the time frame for building that wealth is long. This combination of low relative balance and long time horizon lends itself to being able to take greater risks with investments. Typically, today’s target date funds are happy to oblige with high equity allocations for later vintages of target date funds. Go ahead and take the risk of potentially over-investing in foreign stocks, or commodities, or growth funds. Now is the time to take the risk and hopefully reap the rewards.
It's a slightly different story for older investors. Even if asset growth hasn’t materialized, maybe even especially if balances are not sufficient to support retirement goals, shorter time horizons dictate a certain level of thoughtfulness in investment selection. However, a lot of target date funds are currently too conservative going into retirement. This is somewhat to be expected, since investors were rightfully angry when more aggressively positioned target date funds lost a lot of value in the 2008 bear market. The cautious fund manager knows that trailing its peers when markets are up is better than losing more when markets collapse, especially when the retirement target is near. While some target date funds address this conundrum better than others, your solution is only as good as the option provided in your employer’s retirement plan.
So, when is an investor best suited to abandon his or her target date fund, in favor of a more personalized portfolio? The answer, as in all things financial planning related, is that it depends. It depends on your goals, time horizon, risk tolerance and the size of the investment portfolio. Clearly, if you are happy with your target date fund and feel like it is supporting your long term goals, then there may not be a need to change course. But at some point, many investors are going to need to engage more on how their retirement funds are invested and what risks they are taking (or not) to meet goals beyond just reaching the end of their working lives. The ultimate retirement goal is not only to stop working, but to also continue living in the manner that you have become accustomed, and potentially leave some money behind for beneficiaries. If you need help in hitting your own target, reach out for a review of your retirement plan options and balances.
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