The products promise a smooth glide path to retirement, but experts see flaws in their off-the-rack design
For many individuals who want a hassle-free investment solution for their retirement, target-date funds may seem like an ideal fit. By slowly rebalancing their allocations from favouring stocks to favouring bonds — a long-term task that inattentive investors fail to do themselves — they offer a smooth decades-long glide path toward one’s anticipated exit from the workforce.
The promise of a simple answer to fulfil people’s retirement needs probably appeals to many individual retirees as well as administrators of workplace retirement plans. But as noted by the Wall Street Journal, these products fall short because they fail to consider specific financial needs and circumstances.
“In an attempt to simplify planning and saving for retirement—certainly a noble endeavour—the entire concept of target-date funds likely is a bridge too far,” Robert R. Johnson, professor of finance at Creighton University’s Heider College of Business, told the Journal. “Individuals are unique, and one parameter, the anticipated retirement date, cannot and should not dictate the appropriate asset-allocation mix and the change in that mix over time.”
Another concern arising from such funds’ automatic investing strategy is that they don’t give adequate consideration to changing market conditions. Patrick R. McDowell, investment analyst at Arbor Wealth Management, told the Journal that the low bond-reality of recent yields has resulted in lower incomes for funds that have crossed their target dates, as well as heightened risk of losses on bond holdings in the event that rates rise.
And even if they have the same target date, different funds may hold different levels of risk, as the experience of target-date fund investors during the 2008 financial crisis showed. “While 2010 target-date funds had been gradually shifting their allocations toward bonds, as they were designed to do, many were still holding 50% equity or more when the 2008 financial crisis hit,” said Nicole Tanenbaum, chief investment strategist at Chequers Financial Management.
The main takeaway for target-date investors, therefore, is to do away with any “set it and forget it” views they may have. Experts tell investors to keep track of their fund’s performance, and decide if they are satisfied with what they’re getting. Citing a Morningstar analysis of 15-year fund performance through 2017, the Journal said that 2020 target-date funds lost less on average than the S&P 500 in 87% of the quarters that the index fell. But in up markets, diversified funds will always trail the hottest asset it holds.
Another consideration is funds’ “glide path” policies, which can lie on different points across a spectrum of risk tolerances. “To” funds, which are often designed to hold little to no assets in stocks at the target-date, are most ideal for those who want safety. On the other hand, “through” funds, which typically hold more stocks at the target date, offer more growth to offset inflation and withdrawals throughout a long retirement — but also more risk.
Investors may also want to weigh any tradeoffs in fees. Target-date-funds with fund-of-fund structures typically add one more layer of fees, but those who manage their own portfolios may also incur costs for annual rebalancing, including possible commissions.