The Truth About Target Date Funds

November 11, 2011

I read this article on Bankrate.com about investors’ belief that target date funds come with a guarantee of a sufficient retirement income. The statistics are a little bit startling (51 percent — of people investing their retirement savings in target-date funds see them as a retirement planning panacea and think that putting their money in them guarantees their retirement income needs will be met), frightening even, from the perspective of a financial planner. The conclusion of the article is:

“The bottom line here is that if we are going to have to depend on our own investment abilities and knowledge to retire, almost all of us need more help and education. And the investment advisers we depend on must be persuaded to be completely honest about our investment odds.”

And I couldn’t agree more. More help and more education are becoming more important with each passing year. I’ve commented before about the need for self-reliance regarding retirement. Along with relying on yourself, educating yourself and knowing when to rely on the advice of a professional are important as well. (More on those topics in the next few weeks.)

As for the target date funds, they CAN BE a great idea for many investors. In fact, I own one in one of my IRA accounts. Why? Because I like the fact that it is a simple investment to own and to manage. It’s invested a bit aggressively today (while I still believe that I’m young) and will dial back the risk level as I progress toward retirement. My account is from an old 401(k) from a prior employer and I don’t want another account to manage, so the Target Date fund was an ideal choice for me. These funds use a “glide path” that takes you from aggressive when you’re younger to relatively conservative as you approach age 65, by investing a smaller portion of your money in stocks and more in bonds and cash each year. But, along with being a great idea for many investors they can also provide a false sense of security as mentioned in the article. This type of fund allows me to have growth (or losses) when I need it, and stability when I need to draw money from it. For me, it beats the Stable Value Option type of investment that will simply keep pace (at best) with inflation.

Unfortunately, the way these funds are sold by some advisors and some of the marketing material, can quite easily lead investors to believe that they are safer than they actually are or that your retirement will be safe and secure. That’s called marketing, not promising. For example, my Target Date fund is about 70% stocks right now and 30% bonds and cash. That’s not exactly risk free today, and it’s had some volatility. In 2008, when the stock market plummeted, my Target Date fund suffered substantial losses. It’s not a risk-free guaranteed account. And, it comes with absolutely no guarantee of performance or income during retirement. But, that’s not what I’m looking for. I’m looking for an easy to own fund that “self-manages.”

Does that mean that all Target Date funds are created equal? No, there are differences in fees, how the funds divide money between different types of investments and how that allocation changes over time. This article from the Investment Company Institute delves into a few of these in greater depth, and if you own or are considering owning a Target Date fund, you might want to dig into your fund and know exactly what it is that you own. But, the important thing is to understand that while Target Date funds make it easier and simpler for you to manage risk, unfortunately they can’t completely eliminate it.