3 Ways Target Date Funds May Hurt 401(k) Investors
Target date funds (TDFs) do exactly as the name suggests – they are designed to target your anticipated retirement date.
Instead of having to choose a number of investments and create a portfolio, you select a fund that will help you reach retirement income goals.
So, if you’re younger and plan to retire in 2060, you’d select a 2060 fund. If you’re older and wanting to retire in 2030, you’d select a 2030 target date fund.
Target date funds – also referred to as lifestyle funds and retirement date funds – automatically adjust account allocations throughout an investor’s life.
As you approach your retirement date, the fund moves its allocation to more conservative mutual fund investments and away from riskier mutual fund investments.
Target date funds were created to take away the hassle of having to research mutual funds in your 401(k) and build and construct your own portfolio.
Many investors like them because they simplify the 401(k) investing process, but do they actually live up to the hype? Keep reading for 3 reasons why target date funds may hurt investor portfolios.
#1 TDFs Assume All Investors Have the Same Goals and Objectives
As mentioned above, target date funds put investors in a fund solely based on their expected retirement date.
This means that investors expecting to retire in 2040 are grouped into one fund. Those expecting to retire in 2050 are grouped into another fund.
An individual investor’s retirement goals and risk tolerance are NOT taken into consideration – neither is their profession, salary, past savings experience, and their ability to save.
What target date funds say is that, if you are retiring in 2050, you’re just like every other investor planning on retiring that year and, therefore, should have the same investment strategy.
To further the point, let’s say Kate and Jon are both set to retire in 2030.
Kate has contributed to her 401(k) for over 30 years, has actively managed her 401(k) account throughout the years, and, for the last 5 years, she has maxed out her yearly contributions. Kate’s biggest concern is protecting the money she’s invested.
Jon has also saved the last 30 years, but has not been able to contribute much due to debt and family medical issues. He has not been able to max out his 401(k) contributions. He is worried about making up for lost time and wants to be more aggressive with his 401(k) investments so he has more money in retirement.
The only thing Kate and Jon have in common is their date of retirement – that’s it. They are very different investors.
Based on their situations and goals, does it make sense that they are in the same investment strategy? No, it doesn’t.
#2 TDFs May Not Appropriately Manage Downside Risk
Target date funds will often underperform in good markets and do a poor job of managing downside risk during tough markets.
They do not take into consideration changes in the economy, tax policy, trade, earning reports, or investment trends – and may not make adjustments for any of these driving factors that affect investment performance.
More and more experts claim target date funds may not perform as well as average investors are led to believe.
According to former Morningstar Analyst Jeffrey Holt, ”In the long run, the biggest risk in target date funds is that they won’t meet expectations for avoiding losses.”¹
Citing studies by institutional advisory firm Research Affiliates, Barron’s associate editor Randall W. Forsyth wrote, “They [the studies] show that the standard ‘glide path’ of target-date funds, which start heavily weighted in stocks and reallocate to bonds in later years, doesn’t produce the desired results.”²
According to Rob Arnott, chairman of the board of Research Affiliates, “You now have a trillion-dollar industry based on ideas that were never tested.”³
#3 A Set-It-and-Forget-It Strategy May Negatively Impact Your Retirement Income
Target date funds are popular because of the set-it-and-forget-it approach to retirement savings. Set up your 401(k), contribute, and that’s it.
Herein lies the problem.
This approach may have investors deviating from their retirement goals and objectives – without even realizing it.
Think about it this way: The investments you initially chose to help you meet your retirement goals – whether that was 20 years ago or 2 years ago – may no longer be the best alternatives for you now (especially with the current rapidly changing market conditions).
Things change. You change.
And you should be making appropriate changes in order to stay on course to reach your retirement goals.
Potentially Maximize Your 401(k) Savings
Although you might have basic investment knowledge or are invested in a target date fund, we recommend reaching out for third-party advice.
Utilizing an expert for help with investing and allocating your 401(k) or other workplace retirement account could change the performance of your account from good to great.
In fact, a Morningstar report shows that participants that received expert guidance had as much as 40% more income during retirement versus those who received no help at all.⁴
If you think you’re too close to retirement or don’t have enough money saved, don’t let that stop you.
It’s never too late to take control of your financial future! If you’d like to know How to Supercharge Your 401(k) Performance, download our no-cost guide today.
Sources:
- Special Report: Fidelity puts 6 million savers on risky path to retirement”, Tim McLaughlin, Renee Dudley Reuters, March 5, 2018
- MarketWatch, Opinion: Target-date funds are more expensive and less effective than this simple investment plan, February 20, 2019
- MarketWatch, Opinion: Target-date funds are more expensive and less effective than this simple investment plan, February 20, 2019
- Special Report: Fidelity puts 6 million savers on risky path to retirement, Reuters.com March 5, 2018
