Target Date Funds Revisited - Part 2
By Gary Silverman, CFP®
Last week I began an examination of Target-Date funds. They’re a very popular choice in most retirement plans, yet some people were surprised at how they perform when the stock market takes a big tumble.
As we learned last week, Target-Date funds, like any mutual fund, give you securities-level diversification—they own many of a particular security type. In addition, just like an Asset Allocation fund, they diversify further by owning more than one type of security. For example, they may include stocks, bonds, and real estate. What makes them different is that they take this one step further by changing the fund’s risk profile across time.
People buy the fund with a date close to when they will retire, so the fund manager knows the approximate date that the investor will start using the money. So, as that target date gets closer, less of the portfolio is geared toward growth (generally stocks) and more is invested for income and safety (bonds and cash).
According to the companies who offer Target-Date funds, this is the only investment you need for your retirement savings-- for the rest of your life.
As you can guess, there are some problems with that.
Back in the time of the Financial Crisis (when most stock indexes dropped over 50%) I looked at a representative sampling of no-load Target-Date 2010 funds. What I found was that the funds held anywhere from 32% to 49% stocks and from just about no cash to just under 14%. That year those funds lost from over 9% to over 30% of their value. Imagine being one or two years from retirement and almost one-third of your retirement savings goes ‘poof’.
Now, unlike the average investor, I really don’t mind if a Target-Date fund loses 30% of its value right before the investor’s planned retirement date. I know how to use a fund like this as a part (not the whole) of a retirement portfolio. I know the risks and understand that the fund could lose money. I am prepared for it and plan around it. Unfortunately, the average investor does not.
Because so many investors with these funds lost a substantial portion of their retirement savings, the problems regarding them became clear: 1) Target-date funds with the same target date invest differently from each other, and 2) They all went down a lot more than people were expecting.
This is why the Securities and Exchange Commission (SEC) decided to study how ordinary investors viewed Target-Date funds. And they found that the ordinary investor was quite confused.
To keep you from being confused, we’ll look at some of the results of that study next week.
