Target-Date Funds Are Worrying Me

I can remember a time when many considered companies like IBM, Proctor & Gamble, Xerox and even Sears Roebuck and Company to be “one-decision-retirement stocks” – you buy them, forget about them and enjoy the benefits years later.

In fact – and now I’m dating myself – I remember some investors randomly picking a single stock from the “Nifty Fifty,” which were the 50 most popular large-cap stocks on the New York Stock Exchange in the 1960s and 1970s that were widely touted as great “buy and hold” stocks.

Seems like a quaint idea today, right? Well, I’m starting to get worried that some investors have the same mindset when it comes to Target Date Funds.

Here’s my beef: some investors consider target-date mutual funds as “one-decision-retirement-funds.” And I think that’s risky.

A Quick Primer. Target-date funds go by lots of different names, including lifecycle, dynamic-risk and age-based funds. Usually in a mutual fund format (although often in collective trust funds too), target date mutual funds provide for one-stop shopping and are designed to become more conservative as the “target date” approaches, which is usually retirement or when a child graduates from high school. In fact,
target date funds are mostly used in those two scenarios – saving for retirement and saving for college.

The sponsor of the target date fund – a mutual
fund company – manages the underlying asset allocation. In very simple terms, the mutual fund company will shift the allocation from higher risk/reward investments (equities) to lower risk/reward investments (fixed-income) the closer the “date” approaches.

Too Much Attention. According to the Investment Company Institute, target-date strategies have grown from $116 billion to $763 billion in the past 10 years. And target-date funds accounted for about 12% of all holdings in employer-sponsored retirement plans (401ks) in 2010. But that percentage is on track to jump to almost half in just 3 years.

That’s right – about 48% of all employer-sponsored retirement assets will be in target-date funds in 2020.

A Date When? There are over 2,000 target-date funds, with different asset allocations and different “target dates.” But recently I saw one of the leaders in the mutual fund world launch a new fund with a target date of 2065. That’s 48 years from now!

Geared towards younger investors, can there really be a “one-decision-retirement-fund” that “matures” in 48 years? I’m not going to argue the investing thesis behind the fund – after all, it is managed by a well-respected mutual fund company (let’s just say it rhymes with ran-guard). But I will say this to anyone considering this offering – life is not linear and your retirement planning should not be a single fund. Ever.

Life is Not Linear. Consider the following hypothetical: you are young, say 17 years old and you want to retire at age 65 – 48 years from now. What other life events will happen between now and then? If you’re lucky, you will probably experience many of the following (although probably not in this order):

  • Graduating from high school
  • College
  • First real job
  • First real car
  • Marriage
  • Baby
  • Second Job
  • First house
  • Second baby

And you will likely deal with one of the following during those 48 years too:

  • Loss of job
  • New career
  • Paying for your child’s college
  • Caring for parents
  • Divorce
  • Second marriage
  • Another child
  • Another house

Will a single retirement fund really be able to take all of these life-moments into account? I don’t think so.

Target-Date Funds Do Serve a Purpose. Now, this doesn’t mean that I don’t think target-date funds are useless. Quite the opposite actually. Target-date funds can be extremely useful.

In concept, target date funds can be terrific options for certain shareholders.If you’re considering a target date fund or want to learn more, give me a call so that we can walk through the pros and cons together.

Just don’t use them as a “single-decision-retirement fund.” Ever.

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