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What You Need to Know About Target Date Funds


It's easy to see the appeal of target date funds. They're billed as a simple, safe, convenient solution for saving for retirement. You pick a fund with a diversified mix of assets based on the year you hope to retire. It automatically rebalances, so you just sit back and enjoy the ride.

“On the surface, target date funds appear to be a safe investing alternative, but they are actually very dangerous and will ensure that many retirees run out of money,” says Matthew Tuttle, CEO of Tuttle Wealth Management.

That's a dark prediction, particularly for a product that is one of three designated by the Pension Protection Act of 2006 (PPA) as a qualified default investment alternative (QDIA) for defined contribution plans. Target date funds have become the dominant default investment option. TDFs have taken off. By 2006 they had assets of $114 billion, nearly $250 billion in 2008, and before the market downturn there were predictions that assets would exceed $1 trillion by 2013, according to research from Prudential, Strengthening Target-Date Funds With Guarantees to Enhance Retirement Security.

Target date funds have already proven not to be a panacea. During the stock market turmoil of 2008, target date funds designed for those retiring as soon as 2010 lost as much as 41 percent of their value.

“Target date funds generally still seem to hold too much equities close to maturity. The percentage of stocks that target date funds hold at their target date rose to an average of 43 percent in 2010, from 40 percent in 2007, according to a Brightscope report. That seems too high, especially given the lessons that should have been learned in 2008 and 2011,” points out Kevin Cimring, chief operating officer of Jemstep, a personal online investment guidance and management service.

There are a number of “issues” with TDFs. “They are off the shelf funds that are not customizable. They are retirement date driven only, and do not consider individual risk tolerance or other personal circumstances. For instance, long-dated TDFs could be too aggressive for even young investors who are risk averse,” explains Mike Maglio, investment director for PNC Wealth Management.

Then too, you put asset allocation in someone else's control and you don't really have the ability to manage your overall portfolio according to what's best for you. “One section of your portfolio is a bit of a locked black box,” says Cimring.

Set it and forget it doesn't work. It doesn't allow for changing life circumstance and tactical moves based on economic conditions. “Initial allocations and 'glide path' allocation changes over time, vary across TDFs for equal target dates. Investors should be aware of how initial allocations and glide path changes apply to their portfolios,” says Maglio.

What's also troublesome to Cimring is the conflict of interests. “Holding actively-managed stock funds result in higher fees than bond funds (or index funds, which simply mimic the major indexes such as the S&P 500). That gives the target date managers an incentive to stuff the target date fund with more profitable (and riskier) funds. Target date funds also tend to have higher fees than the underlying funds they hold.”

While the automatic balancing is held up as benefit, some disagree. “Target date funds get more 'conservative' as you get closer to 65. This brings up two problems. What is more conservative? Typically that is bonds, but bonds are in a huge bubble right now and interest rates have no where to go but higher, which would make bonds go down, maybe a lot. The other problem is that people rarely retire at 65 cold turkey these days, and even if they do, they might live for another 40 years, they will still need to earn a decent return on their money,” says Tuttle.

As outlined in Prudential's research, “Target date funds leave participants facing three major risks to enjoying a secure retirement – bear market risk: the risk of significant loss of future retirement income because of sharp declines in asset values in the years immediately preceding retirement; zero balance risk: the risk of running out of money after retiring because of a string of poor market returns or outliving one's assets, and purchasing power risk: the risk of retirement income not growing rapidly enough to keep pace with inflation during retirement.”

Target date funds might be a viable option for those who don't want a say in choosing their investments either because they simply don't want to, or don't feel like they know enough. They are also for those who don't mind paying a bit more for that luxury. But for many people, TDFs might regrettably leave them with the first hand experience that one size does not fit all.


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Comments
7 comments.
Comment #1 by Anonymous posted on
Anonymous
Good article.  Stay away from these funds.  I review the ones offered in several 401k plans and ALL have negative returns for 1yr, 3yr and 5yr time frames.

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Comment #2 by Anonymous posted on
Anonymous
Most of the investments in any mutual fund are designed to make money for the issuer only by charging all kinds of fees from entering and exiting fees to annual maintenence commissions to 12-1b  filing, excluding the market fluctuations. Even if the market stay still, you lose money in all those fees.
So what is the point of gambling your retirement money?

No one with sound mind will expose his money to the sharks of wall street and mutual fund managers. They are the only ones who make the money from your money. You are lucky if you can get alive (broke even) after few years  or decades all the while living in agony.

No investment vehicle can guaranty any profits, including the conservative investors buying only CDs.  I used to get 6%  CDs not long ago, now I settle for less then 2% CDs and are indirectly paying the price (4% fee) for safe investment.

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Comment #3 by Anonymous posted on
Anonymous
I dont understand the Feds logic to further drive down interest rates. I mean, the rates now ae so low that if people dont want to take advantage of these, what is the guarantee that they will if the rates go down further. Besides the low rates is causing people to postpone decisions. In my area rents have started going up and people have started looking to buy as the mortgage payments are less than rents. Maybe the govt should look at increasing rates

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Comment #4 by Anonymous posted on
Anonymous
#3:  What you stated is exactly what the FED wants to occur.  Buy homes (debt) at the expense of savers losing interest income.

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Comment #5 by Anonymous posted on
Anonymous
I think this is needlessly scary.  My own experience is with Vanguard target date funds and yes, people lost money in the 2010 fund that they were'nt prepared to lose. They lost enough that the 457 board dropped the 2010 fund completely, about 30%,  and moved the remaining folks into the Vanguard Target Retirement fund which is more conservative.  I think Vanguard may have modified 2010 since then and made it more conservative.  I actually liked it as a good choice. I was in it after the great collapse and it was a very cheap (0.17% er) way to be in what seemed a scary market.  Almost exactly 50% stocks and 50% bonds.

It's very transparent.  Previously they used several funds to get the stock exposure.  Now it is just two--total US and total intl.  Two bond funds--total bond market and tips. By virtue of their heavy exposure to gov't bonds these bond funds have been pretty good places to be in recent years.

I think it is relatively easy to adjust for risk level with these funds.  Want more conservative?  Go to a shorter date fund. agressive? Then longer.

Even kind of convenient for doing a bit of tactical allocation.  These days I retreat into Vanguard Target Retirement and move an allocation to 2030 if things look good.

It's nonsense about the funds losing at 1,3, and 5 years.  Some did I'm sure.  The blanket statement is absurd.

Do I think employees need to be better informed of there options, risks and the possibility of not just using the default. Yes.  But overall it would be easy to make worse choices.  Security is what we gave up when we walked or were forced away from the horrible nanny state of defined benefit pensions.

Finally, who knows what will happen with a bond fund like total bond market?  If interest rates move slowly then it will probably work out ok.  Certainly there are folks calling into question the very basis of most modern portforlio construction as regarding bonds. Again, this is a situation where the folks who will get hurt the most are the ones who just want to save for retirement and don't understand that they are investing and these investments require at least a modicum of atterntion.  Probably at least monthly in the kind of volatile markets we live in today.  Otherwise, maybe just use the stable value fund.  You won't find a better interest rate for cash, but it won't get you much closer to your retirement goal.  

 

d

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Comment #6 by Bozo posted on
Bozo
Folks, you don't need target-date funds, with their expensive ER's. You need an age-appropriate asset-allocation in low-cost index funds. But, then, I seem to be hitting my head against the wall on this issue.

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Comment #7 by Bozo posted on
Bozo
As you might have guessed, I have "zero" in target-date funds. I am totally "age-in-bonds" and don't need a "target" fund to achieve that.

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