If you’re invested in target date funds, or your employer offers them as part of your 401(k) or another retirement plan, you may want to consider whether they are a good investment option for you. Target date funds are automated investment products that do not take into account your personal financial circumstances and needs, and they do not adapt to changing market conditions.
As a result they may not be effective products for helping you reach your long-term retirement goals, and in some cases they could even add risk to your portfolio over time – hurting your retirement.
Why Are Target Date Funds so Popular?
The appeal of these funds is generally their “auto-pilot” feature – you pick a fund that matches your retirement date, and the fund will diversify your assets and gradually become more conservative as you near retirement.1 For this reason, some may perceive them as low risk investments, but there are issues with this view as you examine target date funds more closely.
3 Reasons to Avoid Target Date Funds
1) They Don't Know Anything About You
When determining your asset allocation at any given time, it’s important to consider your time horizon, your current and future income needs from the assets, your comfort with risk, your growth objectives, and your outside assets. Target date funds arguably don’t take any of these factors into account effectively. Knowing your retirement age is not enough to determine how your portfolio should be allocated.
2) They Do Not Take Market Conditions into Account
Target date funds shift your asset allocation over time to become more conservative, without regard for what’s happening in the markets. Today, this could mean adversely impacting future returns. Given that bond yields are near historical lows, a rise in interest rates in the future could mean bonds experiencing losses. If you’re portfolio is gradually increasing exposure to bonds as this occurs, it could mean adding to your portfolio’s risk without improving returns.1 The same applies to stocks – if you’re decreasing equity exposure during a time when equities are the best performing asset class, there’s an opportunity cost.
3) Research Suggests that it Might Not Pay to Become Too Conservative
In a recent study, Research Affiliates CEO Robert Arnott examined 141 years of stock and bond market performance from 1871 to 2011, and he compared results of three approaches: becoming more conservative over time, maintaining a 50/50 stock and bond mix, and becoming more aggressive over time. In the study, he found that becoming more aggressive over time yielded the best results.
Does this mean you need to go out and buy more stocks? Not at all. The insight we can draw, however, is that automatically shifting your asset allocation into a more conservative position may not necessarily fall in lockstep with your need or desire for growth. In other words, with target date funds, your portfolio might become increasingly conservative even when what you actually need is more growth.1
Opt for a Comprehensive Investment Plan Over Target Date Funds
Instead of choosing a strategy that takes a passive, automated approach to investing, consider investing your portfolio actively with money manager strategies and in-line with your retirement goals and objectives. Such a plan should cater to things like your retirement income goals, your estate planning objectives, how much risk you’re willing to accept, and so forth, and it should change as your needs change.
One of our Wealth Managers can build a comprehensive investment plan for you and recommend money manager strategies designed to help you reach your objectives. Reach us at 1-800-541-7774 or get started on your investment plan by answering a few questions here.
Michael is a Certified Wealth Strategist and Wealth Manager at WrapManager, Inc.
Sources:
1 Forbes
