Is Your Target-Date Fund Missing the Target?
Investing on cruise control is easy, but it may be riskier than you think.
The appeal of
target-date funds is supposed to be "set it and
forget it." Plug in your expected retirement date and a few
investing parameters, and let the algorithms take over.
But recently, some analysts have questioned the
wisdom of a
total hands-off strategy. It's smarter, they say, to keep your
hands on the wheel even if your investment strategy is mainly on
Many people just trust the fund options selected by their
employers, says Richard Davies, head of defined contribution at
investment management and research firm AB (formerly known as
AllianceBernstein). But it's smart to understand the
underpinnings of your target-date fund, partly so you can see if
you need a different strategy to reach your goals, and partly so
you can have an intelligent conversation with the committee that
chooses the fund on behalf of employees at your workplace,
New research from AB indicates that managers of target-date
funds need to focus less on the "glide path" – the investment
transition that gradually shifts assets from growth (usually
stocks) to income (usually bonds) as the retirement "target
date" nears. A better focus, Davies says, is how well the funds
make the most of various types of asset classes, including funds
that are not owned by the plan sponsor.
The emerging term "open architecture" challenges plan
sponsors to make best-in-class choices from a
investment options instead of defaulting to its own funds. "The
investors that have done the best are taking advantage of
diversified asset classes," Davies says. Diversification is
important not only for growth, but also for limiting the
volatility of the portfolios, he adds.
Kevin Coppola, president of Kenilworth, Illinois-based
Compass Investors, a financial analysis firm, says target-date
funds hew to a middle-of-the-road approach that somewhat
insulates investors from both downturns and upturns.
"These things are landlocked within a particular investment
return," he says. "Target-date funds are not going to deliver a
pot of gold."
One basic question to ask yourself: Do you have the right
Many people realize only a few years from their assumed
retirement date that they need to keep working. But that's too
late to adjust target-date funds that have already been
transitioning for years to bonds, analysts say. Instead of
trying to manage the fund by moving the target date, set up a
separate growth portfolio intended to carry you well into your
retirement, they recommend.
"If you're debating about the target date, then go for the
longer one," says Rob Austin, director of retirement research
for Aon Hewitt. "If you expect to live longer, then bet on that
and have your portfolio reflect that."
With the financial headaches of the 2008 financial crisis
still fresh in many investors' minds, some may prefer investment
vehicles they can steer, especially if they are concerned about
market corrections. "If you're worried about making hands-on
decisions if there's an economic shock, you probably don't want
this kind of cruise control," Austin says.
And after the fund hits the target, then what?
Target-date funds largely sunset risk as you transition to
retirement, and that means with little growth in the fund, your
buying power will soon start to erode, Coppola points out.
"It doesn't work beyond your retirement target. You have to
have some money in riskier categories to support your
retirement. You can create an index-based target-date fund with
about half an hour a year and have more control over the mix,"
Coppola says. Most people with
long life expectancies "need
meaningful equity exposure until they're age 80," Davies adds.
"For people who believe they can't [manage their own
portfolios], a target-date fund is a panacea, but they need to
understand what the pot of gold will look like and how big or
small it will be," Coppola explains. "Run some numbers to find
out where you will be, based on your current rates and expected
He and other analysts agree that target-date funds are
complemented by market-focused investments that diversify both
the asset mix and the investment philosophy.
"If you want a passive investment, understand that the
results may not be what you need," Coppola says. "Autopilot
comes with a cost, and it may be more than you have been led to
believe. If you still want to use a target-date fund, then put
some of your money into it, and also take a portion of your
portfolio and invest it responsively to what the market is
doing. Create your own safety net that will break through the
investment return barrier that you'll be locked into in the