Are target-date retirement funds good for you?

By AARON KATSMAN
January 18, 2012 23:42

Before deciding on whether TDFs are appropriate for you, speak with a financial professional.

3 minute read.



[illustrative photo]

Old elderly dementia alzheimers 311 STOCK. (photo credit: Thinkstock/Imagebank)

With many individuals too busy or indifferent to deal with their retirement savings, a relatively new product called Target Date Retirement Funds (TDFs) has surged in popularity. It’s like a one-stop shop for retirement planning.

How does it work?

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We speak a lot about the need to set up a well-diversified portfolio of both stocks and bonds and how to keep it current with your current stage in life. As you are younger and have more time until you retire, you can afford, statistically, to be growth oriented in your investment strategy. But if you are nearing retirement age, chances are that you will need to have a much more conservative portfolio that will generate the income you need to live off of.

TDFs work like this: First, you pick a fund with a date that matches your approximate retirement age. For example, if you are 30 years old and you plan to retire at 65, you pick a target date of 2045. It’s important to note that the funds come with dates that have increments of five years.

The fund manager invests your money in a well-diversified portfolio of bonds and stocks according to various mathematical models on how exactly one should diversify. The risk profile matches what is an appropriate one for someone your age. As you get closer to retirement the fund is theoretically supposed to become much more conservative.

Reallocates for you

I would say that the best feature these funds offer is that they automatically update and reallocate your portfolio as you get older. Whatever asset mix the fund starts out with, it automatically shifts money from stocks into bonds and cash over time, so that the portfolio becomes more conservative and less volatile as you approach retirement.

By the time you retire, the fund is mostly invested in bonds and cash, with a modest stock position to provide some longterm growth. The benefit to you, the investor, is that you don’t have to do anything: You have a one-stop, well-diversified portfolio that is constantly being updated. You can concentrate on your family or your work and not have to give a second thought about whether you are investing properly.

What are the advantages?

I view these types of mutual funds as providing two very important services for investors. One is that they provide a hassle- and time-free way to save for your retirement, while giving you the confidence that your money is being invested in a long-term investment vehicle that fits your personal time horizon. The second reason – more cynical but no less important – is that these funds help save investors from themselves. Investors often hear a tip form someone or have their own good idea and feel compelled to act on them, even though it will have adverse effects on their overall portfolio. With TDFs that issue will not arise because they are managed funds.

What’s the downside?

While at first glance TDFs seem like a perfect investment, they continue to come under fire from many analysts who say they don’t deliver what they promise.

According to a Reuters report: “TDFs have come under fire for maintaining high equity allocations even in funds tailored for investors near retirement age. Many TDF investors near retirement age suffered dramatic losses in the 2008 market crash. Target funds with dates between 2000 and 2010 lost 22.5 percent in 2008, and funds with target dates between 2011 and 2015 lost 28 percent, according to Morningstar. But those are broad averages; some funds with dates as early as 2010 lost as much as 50 percent of their value in 2008.”

This is obviously not what someone about to retire had in mind when making this investment. As such, these analysts believe investors doing retirement planning should either work with an adviser or a fee-based financial planner to personalize a retirement plan that better suits their specific investment profile.

Therefore, before deciding on whether TDFs are appropriate for you, speak with a financial professional to work through all the pluses and minuses.

aaron@lighthousecapital.co.il

Aaron Katsman is a licensed financial adviser in Israel and the United States who helps people with US investment accounts.


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