Target Date Funds Revisited - Part 3

Personal Money Planning |

By Gary Silverman, CFP®

For the last two weeks we’ve been looking at Target-Date funds. This is a re-examination of several articles I wrote on the subject over a decade ago. They were prompted by a report released by the Securities and Exchange Commission (SEC) on how investors perceive these funds. Let’s just say the results showed a lot of confusion.

About half of the people surveyed owned a Target-Date fund. The study gave the participants information about a Target-Date fund in a variety of formats with the goal of measuring what format worked best. The SEC was trying to figure out what language was easiest to understand for the fund prospectuses. As most investors don’t actually read the prospectus, these folks were already more knowledgeable than your average 401(k) or IRA participant.

Even with that, the results were not good. Many participants believed that the funds were designed to be mostly safe investments, like cash, when the target date was reached. Almost two-thirds of the respondents thought the funds guaranteed income in retirement.

While there is a type of Target-Date fund that does stop changing at the date, it is rare. So rare that I’ve never seen one. Besides, that was not the type presented to the survey participants. For the majority of these funds, the asset mix (and therefore the risk profile) changes over time, including after the target (retirement) date. As we saw last week, most have significant stock holdings on and after the target date.

A Target-Date fund has never promised, guaranteed, or otherwise indicated that the fund would generate a steady income during retirement. These funds have a varying mix of stocks, bonds, and other investments. Some years things go very well, and some years not so much. Yet many still think these funds are supposed to be super-safe when they retire.

But here’s the thing; they were never designed that way. 

While Target-Date funds do get less risky as the date approaches, they do not get to a point of no risk. That’s because, as I said before, most of these funds were designed to take you through retirement, not stop when you get there. As such, while income is an important part of the investment mix, growth is still needed. Your retirement will hopefully last two to three decades. Living tends to get more expensive in those later years.

So while stock bear markets can give you problems if you don’t have safer investments in your portfolio, having no stocks create a different problem: a portfolio with anemic growth. If you had a portfolio that didn’t grow, your purchasing power would shrink and so, too, would your standard of living. Having no stocks would present a different problem (inflation risk). Which is why target-date funds don’t shirk stocks even if you’ve shirked working.

I hope these recent columns educated you (or refreshed your memory) about Target-Date funds.  Be clear about what they are and what they are not: They are a very good way to gain exposure to a wide range of investments with little fuss, but they are not a panacea. As with any investment, before you throw your money at it, it’s crucial to understand your goals.