Target-Date Funds: Should You Just Set it and Forget it?

Over the last decade, target-date funds have been the go-to mutual fund investment for many people saving for retirement. They are the default fund for many 401(k) plans for plan participants who do not want to make their own fund choices. They are a popular choice for anyone who is not inclined to learn the ins and outs of investing with the idea they can just set them and forget them. But should they?

Target Funds’ Shaky Start

Although most retirement planning experts laud the concept of target-date funds, designed to continuously adjust the investment allocation from more aggressive to more conservative as investors approach and enter retirement, they got off to a shaky start. Most target-date funds had a bad run during the steep decline of the 2008 stock market. As a result, they drew the ire of legislators who wanted to regulate them to protect seniors. Still, the basic premise of target-date funds remains sound, and they have performed more true to form in recent years.

Pros – Cons of Target-Date Funds

Target-date fund critics have been relatively vocal about the notion that they tend to be weighted too heavily towards stocks even as they approach the target date. Others are quick to suggest that “savvy” or “informed” investors could better allocate assets on their own. While the former critique may have merit worth investigating, the latter critique can be dismissed because target-date funds are not designed for savvy or informed investors.

The fact is that nearly 80% of the adults deem themselves inadequate in their knowledge of investing, and 40% of those do not trust the advice offered by stockbrokers or financial advisors. So, where does that leave them? While this segment of the population may feel they lack the necessary investment acumen, the vast majority are smart enough to know that money sitting in a savings account will not produce the asset growth they need to secure their retirement.

The recent performance of target-date funds indicates that many target-date funds tend to be more stock weighted than some investment planning rules-of-thumb. However, as the portfolios neared the target date, they achieved a proper allocation weighted more towards short-term income securities, appropriate for the needs of investors nearing retirement. The actual allocation between equities and fixed income securities varies somewhat from one fund to the next, but most were in a suitable range for pre-retirees.

Boomers Need a Boost

The reality for many pre-retired Baby Boomers is their retirement portfolios will need a more substantial stock weighting than their parents who retired in comfort sitting on top of the huge stock and housing market gains of the 1980s and ’90s. With the low yields of today’s fixed-income investments, retirees will need greater exposure to equities to maintain their purchasing power over a 20- to 30-year retirement. But that does not necessarily mean they have to take more risk.

A Target-Date Fund Strategy a Risk-Adverse Retiree Could Like

While there may be an increased risk for retirees maintaining a heavy equity exposure in their target-date funds, the risk of outliving their income may be greater if they do not. One target-date strategy retirees have been using with much success is to create a target-date fund ladder. Rather than have all their funds targeted at their retirement date (per design), they employ a laddering strategy whereby their target dates are staggered every five years.

For example, the first date targeted is their retirement date. Another fund can be targeted to a date five years beyond their retirement date. And another fund targets a date ten years out. This enables them to maintain long-term growth potential while protecting near-term capital with a more conservative allocation. This laddering strategy can boost a retiree’s lifetime income sufficiency without incurring more risk than is necessary.

Certainly, they are not for everyone, but target-date funds should not be dismissed out of hand by anyone who has their sights on retirement but their mind on other things.