A decade after target-date funds were damaged during the financial crisis, they have re-emerged bigger than ever as retirement investments. But they still have vulnerabilities.
“While 2010 target-date funds had been gradually shifting their allocations toward bonds, as they were designed to do, many were still holding 50% equity or more when the 2008 financial crisis hit,” says Nicole Tanenbaum, chief investment strategist at Chequers Financial Management, a financial-planning firm in San Francisco.
“The funds were down less than the stock market during the crash, thanks to their bond component, but the performance still took many retirement-ready individuals by surprise as they watched their portfolio losses balloon into double-digit territory,” she says.
.. A big factor in that growth was Obama-era legislation that encouraged employers to automatically enroll new employees in retirement plans and use target-date funds as the default for those who don’t choose their own investments. Previously, investors who were inattentive—a notorious problem with workplace retirement plans—simply accumulated cash, which doesn’t provide enough growth to build a nest egg that will last for decades.
“It’s certainly a good thing” to use TDFs as the default, says Dennis Shirshikov, financial analyst at FitSmallBusiness.com, an advice service for small-business owners and managers. “This has brought a great deal of consistency to a retirement portfolio, especially since most investors with a 401(k) do not manage their investment actively.”
.. Retirement experts have mixed views about TDFs’ value in a portfolio. Most say TDFs are better than not investing at all, or putting retirement savings in cash, but the funds can’t take into account each investor’s unique situation. Two investors the same age would get the same fund, even if they have different needs due to dependents, availability of other assets, life expectancy and risk tolerance.“In an attempt to simplify planning and saving for retirement—certainly a noble endeavor—the entire concept of target-date funds likely is a bridge too far,” Prof. Johnson says. “Individuals are unique, and one parameter, the anticipated retirement date, cannot and should not dictate the appropriate asset-allocation mix and the change in that mix over time.”Retirement experts have mixed views about TDFs’ value in a portfolio. Most say TDFs are better than not investing at all, or putting retirement savings in cash, but the funds can’t take into account each investor’s unique situation. Two investors the same age would get the same fund, even if they have different needs due to dependents, availability of other assets, life expectancy and risk tolerance.
Another concern: The automatic investing strategy ignores changing conditions. Patrick R. McDowell, investment analyst at Arbor Wealth Management in Miramar Beach, Fla., says low bond yields in recent years have reduced TDF income after the target date, and increased the risk of losses on bondholdings if rates rise. (Higher rates hurt bond values because investors favor newer bonds that pay more.)
What’s more, he says, stocks and bonds have often moved in tandem in recent years, reducing the benefit from diversification, which assumes one asset goes up when the other falls.
.. He says he often recommends investors nearing retirement leave the target-date fund and buy a mix of stock and stable-value funds—which contain bonds insured against loss and are designed to preserve capital while generating returns similar to a fixed-income investment—to reduce danger from a potential market plunge.
.. Advisers also urge investors to examine the TDF’s “glide path”—its investing policy for shifting from stocks to bonds over time—and pick one that suits their willingness to take risk. Some fund companies provide more than one glide path to the same date, ranging from aggressive paths that rely more on stocks to conservative ones heavier on bonds.
“To” funds are designed to hit their final mix at the target date, often with little or nothing in stocks. They work best for investors who want safety because they expect to cash out or switch to another investment at the target date.