Inside Target Date Funds: Some Myths and Misconceptions
An “average Joe-anna’s” take on target date funds
[A guest blog by Safe Harbor’s own Susanna Johnson]
Set it and forget it! That sounds like my cup of tea when it comes to investing. I’ve got better, more pressing things to do than worry about the money my husband and I (begrudgingly – quite frankly) set aside for our future retirement. In fact, between middle school concerts, that weird sound my minivan is making, the dog’s sock stealing habit, the ice-maker that refuses to make ice, and my teenager embarking on the quest to figure out what college to go to and what to do with his life; I can barely imagine myself making even making it to retirement! So, when I was introduced to this amazing concept of a Target Date Fund, I figured that was for me. I’ll be guaranteed that dream house by the lake when our kids are successfully self-sufficient and contributing to society, right? Well, if it sounds too good to be true, it probably is.
What is a Target Date Fund (TDF)?
A TDF (aka a Lifecycle Fund for Federal Thrift Savings Plan participants) is a mutual fund that has a predetermined asset allocation of stocks, bonds, cash, and other investments based on the number of years from the selected target date. This is also referred to as the retirement date – assuming that is the date you plan on withdrawing money from that account. Allocations are adjusted over time – more aggressively invested (more stocks than bonds or cash) when you are younger and systematically rebalanced to become more conservative (more bonds and cash and less stocks) as you grow closer to your retirement date. Ideally, or at least theoretically, no matter how volatile the market is when you need to take money out, it won’t affect your bottom line as much because your portfolio has conservatively shifted to a fixed income focus.
What TDFs CAN do:
TDFs expose you to a variety of markets and a selection of asset allocations as a long-term investment. TDFs take some of the investing burden away from the investor by having professional investment managers make changes over time to adjust the portfolio’s stock and bond allocations that, otherwise, are left up to the individual investor to make (or not as is often the case). They keep you on track by automatically rebalancing behind the scenes back to the current target allocation in response to market movements.
What TDFs CAN’T do:
TDFs cannot guarantee that you will meet your income needs in retirement. That is what they are designed to do, but alas no one can predict the future. Even if your financial advisor alludes to the assurance of such a plan, it is still possible for your account balance to go down due to fluctuations in the stock market over time. There are no guarantees about your investment returns and, unlike bank accounts, TDFs are not insured by the government, so you could potentially lose your investment if a fund gets into financial trouble. Like any stock and bond market investment there are risks involved in investments in target date funds.
Not all TDFs are equal!
Even though all TDFs have the same basic approach to move along a “glide path” that has the goal of reducing the investment risk over time by reducing the stock allocation and increasing the bond and cash allocation, to the surprise of many, fund managers do this in very different ways at different companies. They vary in management strategies, underlying funds, risk/reward characteristics, allocation percentages over time, investment costs, and whether they manage to the target date or through the target date. Therefore, your portfolio will look very different, depending on which TDF you choose.
Glide Paths of some of the more popular TDFs:
|TDF FUNDS||AT TARGET DATE STOCK % / BOND%||MANAGED “TO” OR “THROUGH”|
|American Funds||50/50||THROUGH 30 years|
|Fidelity||60/40||THROUGH 18 years|
|Schwab||40/60||THROUGH 20 years|
|T. Rowe Price Retirement||55/45||THROUGH 30 years|
|T. Rowe Price Target||40/60||THROUGH 30 years|
|Vanguard||50/50||THROUGH 7 years|
|Federal Thrift Savings Plan||20/80||TO; Becomes Lifecycle Income Fund at Target Date|