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Target-date funds have emerged strongly from the damage of 10 years ago, but some advisers say their one-size-fits-all approach to investing isn’t suitable for every investor. Nicolas Ortega
Journal Reports: Funds/ETFs
What We’ve Learned About Target-Date Funds, 10 Years Later
A decade after target-date funds were damaged during the financial crisis, they have re-emerged bigger than ever as retirement investments. But they still have vulnerabilities.
By Jeff Brown
May 5, 2019 10:09 p.m. ET
Back in 2008, many investors looking ahead to retirement in two years had a shock when “target-date funds” designed for them plummeted in value. Many had assumed those funds, targeted to a 2010 retirement, were safe from large moves that late in the game.
Despite the jolt to investor confidence, target-date funds have flourished in the decade since, becoming a staple in workplace retirement plans such as 401(k)s, as a net $532 billion in investor money poured in during that time, according to data from the Investment Company Institute trade group.
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Whether that is a good thing remains a matter of debate. Some financial experts question the value of target-date funds, saying their one-size-fits-all approach to investing isn’t suitable for every investor. Others say the funds can be a good way to save for both retirement and college—as long as investors pay attention to the products’ risk profile, fees and performance, especially as market conditions change.
Of course, the idea behind target-date funds, or TDFs, is to make investing as simple as possible by gradually adjusting to a more conservative investment mix as a target date approaches. As the default option in many workplace retirement plans, TDFs attract investors who don't want to choose and rebalance their own investments and may not be aware that the funds can still own lots of risky stocks close to and even after the target date arrives.
“There is a common misconception among many target-date holders that the portfolio is completely de-risked at retirement, and that simply isn’t true,” says Robert R. Johnson, professor of finance at Creighton University’s Heider College of Business in Omaha, Neb.
A big factor in that growth was Obama-era legislation that encouraged employers to automatically enroll new employees in retirement plans and use target-date funds as the default for those who don’t choose their own investments. Previously, investors who were inattentive—a notorious problem with workplace retirement plans—simply accumulated cash, which doesn’t provide enough growth to build a nest egg that will last for decades.
“It’s certainly a good thing” to use TDFs as the default, says Dennis Shirshikov, financial analyst at FitSmallBusiness.com, an advice service for small-business owners and managers. “This has brought a great deal of consistency to a retirement portfolio, especially since most investors with a 401(k) do not manage their investment actively.”
Another factor in TDF growth, Morningstar says, is the growing popularity of index investing as most TDFs invest in index funds, rather than actively managed funds. In 2017, 95% of new employee contributions to TDFs went to one relying on index funds, according to Morningstar.
Investors can buy target-date funds for their individual retirement accounts and taxable accounts, as well, and most big fund companies offer them. The biggest player is Vanguard Group with about $381 billion in TDF assets in 2017, 34% of the market, Morningstar says. Fidelity Investments had a 20.5% share, and the third-biggest player, T. Rowe Price , TROW 1.89% had a 14.9% share.
The downsides
Retirement experts have mixed views about TDFs’ value in a portfolio. Most say TDFs are better than not investing at all, or putting retirement savings in cash, but the funds can’t take into account each investor’s unique situation. Two investors the same age would get the same fund, even if they have different needs due to dependents, availability of other assets, life expectancy and risk tolerance.
“In an attempt to simplify planning and saving for retirement—certainly a noble endeavor—the entire concept of target-date funds likely is a bridge too far,” Prof. Johnson says. “Individuals are unique, and one parameter, the anticipated retirement date, cannot and should not dictate the appropriate asset-allocation mix and the change in that mix over time.”
Another concern: The automatic investing strategy ignores changing conditions. Patrick R. McDowell, investment analyst at Arbor Wealth Management in Miramar Beach, Fla., says low bond yields in recent years have reduced TDF income after the target date, and increased the risk of losses on bondholdings if rates rise. (Higher rates hurt bond values because investors favor newer bonds that pay more.)
What’s more, he says, stocks and bonds have often moved in tandem in recent years, reducing the benefit from diversification, which assumes one asset goes up when the other falls.
Know your rights
Retirement savers who are automatically put into TDFs have the right to switch to other funds in their retirement plan as they learn more or conditions change, and Mr. McDowell recommends that investors get more involved as retirement nears. He says he often recommends investors nearing retirement leave the target-date fund and buy a mix of stock and stable-value funds—which contain bonds insured against loss and are designed to preserve capital while generating returns similar to a fixed-income investment—to reduce danger from a potential market plunge.
Advisers urge investors to examine the TDF’s ‘glide path’—its investing policy for shifting from stocks to bonds over time. Photo: iStock
“In that strategy, a big drop in equity and fixed-income prices won’t hurt a soon-to-be retiree in the same way it would in a TDF strategy,” he says. “It also helps investors defend against a rising interest-rate scenario” harmful to bonds.
Experts say TDF investors should keep abreast of performance and not just assume they are on track to a comfortable retirement. Morningstar provides data on average performance by target date, as well as details on individual funds.
