Is a Target Date Fund for You?
The growing trend among mutual fund families and especially in 401(k) plans is the target date fund (TDF). These are asset allocation funds that assume the investors will reach retirement age at a certain year, hence the name Target Date. There’s an ongoing debate over whether the funds are good for investors. The idea is that they take the load of asset allocation off the investor. The fund starts with an allocation based on the assumed age and risk level of the investors. As the investors near retirement age, the portfolio is adjusted to be less risky and volatile. Once retirement age is reached, there’s more of an emphasis on income and stability than on growth.
That’s the theory. The implementation is different based on the financial firm sponsoring the TDF. In general, TDFs didn’t shine during the financial crisis. TDFs are allowed to change their asset allocation based on factors other than the age of the investors. Many of them increased their equity allocations during the last stages of the bull market, regardless of the assumed ages of the investors, because they didn’t want low performance numbers during a stock rally. The result was a number of TDFs lost substantial value for investors in or near retirement in 2008 and 2009. Some funds, realizing that retirement is likely to last 20 years or longer, believe investors still need growth at retirement so they keep high equity allocations well after the target date.
The point is that TDFs are not equal. The concept is great, I think, but the execution varies. Whether you should use the TDF offered in your 401(k) plan or by a prominent mutual fund family depends on the fund. Here’s a good summary of the current situation. I like the idea of TDFs for most investors, because they don’t know much about investing and don’t want to spend much time on it. But TDFs aren’t generic, so you have to tread carefully. Which means the TDF industry failed in its basic precept, which is to take most of the burden off the individual investor.
“Workers are delegating back to their employer the asset-allocation decision,” says Stephen P. Utkus, principal of the Vanguard Center for Retirement Research. Put another way, workers are delegating to their employer, who is then delegating to the plan provider it has hired, to run a target-date fund within a 401(k). The T.D.F is typically comprised of a mix of mutual funds run by the plan provider.
There is a very wide range of T.D.F.’s, and that may be a problem because they have a whiff of the old Wild West about them: just about anything goes. For example, Morningstar found that among three dozen funds with a target retirement date of 2025, the percentage of fund assets invested in stocks ranged from 38 to 86 percent, with an average of 70 percent. The retirement investment industry and Washington regulators have basically left it to investors to figure out what their T.D.F.’s contain, and to decide if their plan dovetails with their risk and return expectations.
