As technology has developed, things have become easier. Before the Internet Age, we needed to go to bookstores to buy books. Now we can buy almost anything with just a few clicks of the mouse. In the past few years, this trend toward simplicity and ease has moved to investing. Welcome to the wonderful world of target-date funds.
At first glance, the target-date system seems straightforward enough. Buy a fund that corresponds with your year of retirement, never look at it again, and it will re-allocate your investments without your ever having to lift a finger. The fund grows increasingly conservative as you near your retirement date, and once you retire you’ll have enough money to support yourself from there on out. Piece of cake.
If only it were that simple.
There are a number of things to know before you put all your money into a target-date fund. First: you need to put all of your retirement money into the account for it to work as it is supposed to. For example, say you put 75% of your money into a target-date fund and it allocates 60% of your money in stocks and 40% in fixed income. Then say you take the remaining 25% and place it in value stocks, as the target-date fund does not offer value investing. Your allocation will be off: you will be investing too aggressively for your target date of retirement.
Second: not all target-date funds are created equal. Whether or not they share the same target date, funds are idiosyncratic entities, and each one has its own type of allocation and style of investing. There are discrepancies regarding percentages of fixed income, and the aggressiveness of each fund. In short, you need to study, know, and understand your chosen target-date fund before you put in your money.
Third: target-date funds do not change strategy if, due to conservative allocations or poor performance, your funds fail to grow at the ideal pace. You yourself need to change to a more aggressive fund in that case. In other words, you can’t go to sleep and let the target date fund do all the work for you. You still need to keep track and analyze how the fund is doing and make sure it is meeting your goals.
Most important: target-date funds have not been around long enough for us to know all the potential problems. During the market downturn of 2008 and 2009, a major flaw in the system was exposed. The market downturn exposed many target-date funds, and numerous investors discovered they had been exposed to more risk than they had realized. For example, according to Watson Wyatt Investment Consulting [i] , target-date funds with a target of 2010 had a median return of -31.9% between October 2007 and February 2009. Additionally, the 2008 returns for funds with a target of 2010 were spread within a range of 26%; highlighting the discrepancy between investing strategies of target-date funds. For a target date of such a short period of time, where most of the investments should have been in fixed income, these results represent an astoundingly large loss and a worrisomely wide variation between returns.
Some claim that the benefit of a target-date fund is that it’s cheaper than hiring an investment advisor, which in turn off-sets some of the fund’s less savory attributes. This is a misconception. The average target-date fund expense is 1.15%, according to Morningstar, Inc. The average advisor fee is approximately 1%, plus some additional costs for ETF’s, Mutual Funds and transaction fees. The difference is not substantial, and the benefits of an advisor probably outweigh the negatives.
All this is to say that target-date funds are not the quick-and-easy solution they are sometimes touted as. They must be heavily researched and kept under close supervision if you want to get your money’s worth. All in all, they may just not be worth it.
Eitan Tashman, MBA, Chartered Retirement Planning CounselorSM
Eitan is a fee-only financial planner and investment advisor and can be reached at [email protected] or 323-782-9600 ext. 17
Information presented in this article is believed to be factual and up-to-date, but we do not guarantee its accuracy and it should not be regarded as a complete analysis of the subjects discussed. All expressions of opinion reflect the judgment of the author as of the date of publication and are subject to change.
Information presented does not involve the rendering of personalized investment advice, but is limited to the dissemination of thoughts and opinions on investment topics.
[i] Press Releases: Target-Date Funds Require Better Benchmarking, Watson Wyatt Says – June 2009