Understanding the Risks of Target-Date Retirement Funds

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by DAVID NOVAK

One of the relatively new products in the investment world is the target date mutual fund. In this type of fund, an investor selects a portfolio with a future date that is expected to coincide with a particular event – most commonly retirement.

As this date approaches, the company managing the fund automatically adjusts the asset allocation to get more and more conservative in anticipation of the investor needing access to at least a portion of the money.

These funds have become very popular in the last 15 years or so of their existence – so popular in fact, that according to Vanguard, approximately half of retirement investors had their entire account invested in a target-date fund in 2017.

This “set it and forget it” strategy sounds like a no-brainer for investors – what could be wrong with it?

Plenty, it turns out.

Let’s start with fees. These funds are considered “funds of funds,” meaning they are simply mutual funds that own other mutual funds. Obviously, these extra layers mean that internal expenses can add up quickly.

Another issue with the target-date retirement fund is consistency. While you may think that target-date funds with the same retirement date would have a similar weighting in stocks and bonds, this is actually not the case.

Among the most common target-date retirement fund providers like Fidelity, Vanguard and T. Rowe Price, there is a meaningful difference in asset allocation even for the same designated retirement year.

Perhaps more concerning than this disparity is the fact that with a target-date fund, you are locked into a single fund family so your entire portfolio will be invested only in one fund family’s mutual funds.

In more than two decades in this business, I have yet to find one family that excels in all areas of asset allocation.

Possibly the most underappreciated problem with target-date funds is how they treat fixed income. Because traditional views on asset allocation would equate being more conservative with having a higher percentage of the portfolio in bonds, target-date funds are structured as such.

The problem is that in an environment where interest rates rise, bond funds will struggle to break even since bond prices move inversely to the direction of interest rates.

Before you put your retirement portfolio on autopilot, make sure you understand all the risks of target-date funds.

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David Novak, CFP® is a Certified Financial Planner™ at Novak & Powell Financial Services in Pinellas County.
Please note: David Novak is not an attorney and this article should not be construed as one offering legal advice.
For information about investment decisions and
financial planning, contact him at (727) 451-3440.

 

 

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