Target Date Funds: The Good and the Bad
Do you know when you are looking to retire? A target-date fund might be an option for you if you have an estimated retirement date in mind. What target-date funds essentially are a fund of funds geared toward a specific retirement year. They could be a good simple way to invest your money and make the most of it based on the number of years you have left in the market.
Let’s consider a real-world example. You are planning to retire in the year 2050 so you would invest in a 2050 target-date fund. This particular fund is geared to start with a more aggressive investing style to reflect the accumulation and growth phase. Over time, it slowly shifts to a more conservative allocation as time goes by and retirement nears.
Though this simplistic approach might seem like a good fit, is it really advantageous? Would it be a good idea for you, or would you be better off having a more tailored portfolio? Let’s explore the pros and cons.
Conceptually, target funds are a great way to invest your hard-earned dollars. They are a simple solution that benefits a lot of people who otherwise would be uncertain about what asset classes to invest in. Target date funds are also great for individuals who do not want the headache of rebalancing their portfolio over the years or those who are simply intimidated by the entire process of investing.
Additionally, the broad range of new options between active and passive investments have made it easier to appeal to a wider variety of investors. Target date funds’ simplicity definitely offers a unique advantage.
In theory, target-date funds are a great tool, in practice however, they don’t come without a few downsides too. The one-size-fits-all theory is efficient and it works for some people, but it is inherently flawed as an investment method. The reality is that each person is unique. Their financial circumstances are different, as are their goals and needs. The simplicity of a target date fund might be alluring but no two funds are exactly the same. Here is an example:
Different funds will have different allocations for the same target retirement date. It is not uncommon to see a fund at 60 percent equities at the target date and another at only 40 percent. It may also target sub-asset classes such as large-cap versus small-cap or broad international versus developed and emerging markets differently. This makes for a huge difference in the end result.
Additionally, you have to think about the overall expenses. A large number of target-date funds charge a management fee not only for the fund itself but for the underlying as well. This technically requires you to pay a double fee for a generic one-size-fits-all fund. Instead, you could be getting professional advice from a fiduciary advisor which includes complete comprehensive financial planning along with investment management for a price not much different than that of an actively managed fund!
Looking at the bigger picture, you can see that this simplistic approach is not so simple after all. Here are the main key points you need to look for if you decide to invest in a target-date fund:
· Asset Class Diversification: What asset classes are included and what are the allocation start and endpoints?
· Investment Vehicles: Does my target date fund use mutual funds, exchange-traded funds, or something else entirely?
· Rebalancing: How is the policy surrounding drift in allocation?
· Speed of Glide Path Progression: How quickly or slowly is the change in allocation happening as I get near or through retirement?
The bottom line is this: target funds aren’t awful in nature. In fact, they do have some positive sides to them that are great for do-it-yourself investors. They could even be great for people who otherwise would not invest. However, simply “good enough” should not be all you are aiming for. Instead, focus on having an investment plan that fits with your overall investment strategy and financial plan. If you don’t have one of these yet, be sure to get with your fiduciary financial advisor as soon as possible.