A growing fad in 401(k) plans is Target Date Funds (TDF). While these funds serve a purpose for those unsure of how to invest their retirement accounts, I almost never recommend them for clients. I believe these generally have more negative (vs. positive) repercussions. With this blog, I’d like to educate on a TDF’s inner workings (which may shed light on my dislike).
What is a Target Date Fund?
A TDF (also referred to as a “lifestyle fund” or “target retirement fund”) is generally a “fund of funds.” While it appears as a single mutual fund on the surface, underneath are multiple mutual funds which change in allocation over time. It provides a simple approach to investing, as one only needs to select their retirement date. The mutual fund then works like a glide path, becoming more conservative as the investor gets closer to their target date.
For instance, Fidelity’s Freedom 2020 fund is geared for investors who plan to retire at (or around) the year 2020. This fund is approximately 58% equity and 42% fixed income. Let’s compare that with Fidelity’s Freedom 2060 fund. This one is geared for individuals looking to retire around year 2060 (I can’t even think that high!). This fund is approximately 92% equity and 8% fixed income.
You can see, as one gets closer to their target date the fund gets increasingly more conservative. So why do I find an issue with this strategy? Aren’t investors supposed to get more conservative as they get closer to retirement?
Why the beef?
I truly don’t believe investment management can ever be a “one size fits all” mentality. Just like a pair of jeans, they all come in different varying sizes; the variety makes them viable to the consumer. (Don’t worry, I’ll save my logic on jeans for a separate blog.) For investing, there are much better ways than a “set it and forget it” Target Date Fund.
For starters, should everyone looking to retire in 40 years be exposed 92% equity? Conversely, should those looking to retire in the next two years be 42% in fixed income? I have seen enough clients to know not all risk tolerances match with these assumptions. What if your financial plan, and other long-terms goals, require more growth in retirement from your investments? Will these TDFs adjust to your specific needs, goals, and expectations? The quick and simple answer is: No. They will not.
I know every client’s needs, goals, and comfort levels are unique. All should be carefully considered when developing an appropriate investment allocation. Each individual has their own interpretation of what is “high risk” when looking at risk and return.
It’s a fact: these TDFs don’t know you. They don’t know your financial plans and won’t adjust to your needs. They are a rigid pair of jeans that don’t conform to your body.
Financial and investment planning are things which take a lot of customization and partnering to fit just right. A Target Date Fund is a “one-way” relationship. It doesn’t listen to you and does what it wants. You don’t want that in your personal life and I’m here to suggest there are better ways to handle it in your financial life.
One of the reasons we exist as financial planners is to carefully craft a sound investment strategy which grows with you and is tailored to your needs. A sound strategy adjusts accordingly over time to better fit your needs (just like your favorite pair of jeans).