Investing In Multiple Target Date Funds

Should You Invest In Target Date Funds

The concept of moving from aggressive to conservative investments over time is widely accepted in the financial community. The problem is, the one-size-fits-all approach of target date funds can keep your nest egg from reaching its full potential.

We dont believe in the target date fund method because people live longer than they think they will after retirement, and switching your investment mix to be more conservative wont give your money a chance to grow above the rate of inflation. That means you could outlive your savingsand no one wants to end up in that position.

Instead, we tell people to invest in growth stock mutual funds and meet with an investing professional who knows your personal situation and goals. That way, they can help you manage your retirement investmentsand the risk of those investments.

To show the difference, Im going to walk you through an investing scenario. Imagine two investors, Jill and Kate, start investing at age 30 and contribute $250 a month to a Roth IRA, but they choose different fund options.

• Jill invests in individual growth stock mutual funds after discussing her options with her investing professional.

• Kate invests in a target date fund.

Kates nest egg is only worth around $800,000. Thats $400,000 less than what Jill earned with mutual funds! And thats because of a mere 3% difference in return in the last 15 years.

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Retirement Savers Are Misusing Target

Target-date funds, in theory, offer retirement savers a no-fuss way to invest without having to worry about allocations, rebalancing, and glide paths. Just pick a fund closest to the date youd like to retire and then sit back while the fund does the work.

But many workers, including those who invest in the common 401 plan offerings, lack a basic understanding of target-date funds function and end up misusing them, according to a whitepaper titled Five surprising facts about target date funds from benefits-solutions provider Alight Solutions.

The study, which examined about 2.5 million investors in target-date funds, found that only 11% knew that the funds are structured so that workers need to invest in only one fund and only 14% knew that the funds rebalance over time.

Rob Austin, vice president and head of research for Alight Solutions, says one contributing factor to the lack of understanding surrounding target-date funds is that theyre built around a single variablethe age of the workerand dont incorporate factors such as risk tolerance, different attitudes about active and passive investing, different savings rates, existing 401 balances, and other household assets.

You could have people who are about the same age but have drastically different investment outlooks, he said.

Here, three common ways investors are misusing target-date funds:

But in most cases, Austin said, using multiple TDFs is like going on several diets at once.

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Target Date Retirement Funds

Investing for retirement can be complex. When deciding where to invest, you may need to make a variety of decisions, including how to balance the risk of losing money with the desire to increase your returns, keeping in mind that inflation may reduce the purchasing power of your savings and you or your spouse or partner may live longer in retirement than you expect. Recognizing this, a number of companies offer target date retirement funds, sometimes referred to as target date funds or lifecycle funds.

These funds are designed to make investing for retirement more convenient by automatically changing your investment mix or asset allocation over time. Asset allocation involves dividing an investment portfolio among different asset categories, such as stocks, bonds, and cash investments. Once you select a target date fund, the managers of the fund make all the decisions about asset allocation.

Target date funds are often available through 401 plans. Some 401 plans use these funds as the default investment for plan participants who have not selected their investments under the plan. Both before and after investing in a target date fund, consider carefully whether the fund is right for you.

Diversifiers Can Help Cushion Downside In Rough Markets

One such factor is sound portfolio structure. More diversified asset-class exposure and more robust glide path construction are even more critical in times like these. Diversifiers such as long/short equities, unconstrained bonds and market-neutral strategies can provide additional sources of uncorrelatedor less correlatedreturns versus traditional stocks and bonds, and they may help reduce overall portfolio risk, including the potential for losses.

For example, when the US bond market declined by more than 3% in the period surrounding the US presidential election of 2016, fixed-income diversifiers generated a positive return that helped offset the bond sell-off. More recently, when global equity markets fell by more than 5% in early 2018, equity diversifiers fell by only half as much, moderating losses.*

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Why Consider Target Date Funds

Target date funds make it easy for people looking to save for retirement to potentially maximize their future retirement income. If you have a 401 plan, you may already be invested in a target date fund, since many plans use them as their default investment. Depending on your retirement goals, there are several investment strategies you can consider when getting actively involved in selecting a target date fund.

How To Assess Target

TDFs have grown in popularity within the past decade. But make sure you keep certain points in mind before you invest in one.

• Fees: Expenses vary across different TDFs
• Asset allocation: Two TDFs named after the same year can have drastically different asset allocations and glide paths. So make sure you know what youre investing in.
• Performance: Analyze the performance of your TDF options over the years

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Underlying Funds Offered By Same Company

Beyond expenses, another consideration is that each of the underlying funds in a target portfolio is offered by the same fund company. Every target fund in Vanguard’s lineup has nothing but other Vanguard funds inside the portfolio. The same goes for the Fidelity and T. Rowe funds. In an era with more than a few corporate scandals on record, you are trusting all of your assets to a single fund family.

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The Statistics Are Clear

Statistics show the popularity of these funds. As of 2020, more than 50% of 401 investors have all of their 401 assets in target-date funds. More than 75% of investors have a portion of their money in at least one target-date fund, according to a study from Vanguard, which is a leading index-fund provider.

Part of the reason for the explosion is because the funds are often the default investment choice for 401s. If you meet with your human resources representative or maybe a plan advisor, theyre likely to steer you toward a target-date fund because it allows for a hands-off approach to retirement planning.

Who Actually Benefits From Target-Date Funds?

How Do Target Date Funds Work

Suppose your employer offers a tax-advantaged retirement plan, like a Roth 401. You arent sure what kind of investment options to pick, so you go with a target date fund.

Lets say its 2020, and youre 45 years old. You want to retire at age 67, so you select the 2040 Fund so you can access it in 20 years. Over that 20-year period, your money will first be put in aggressive, high-risk, high-return stock mutual funds, then move gradually to conservative, low-risk, low-return bond funds.

Here are some real examples of target date fund options . Notice how the funds with a closer target date are invested less in stocks and more in bonds:

• 2065 Fund: 90% in stocks 10% in bonds1

• 2040 Fund: 85% in stocks 15% in bonds2

• 2020 Fund: 55% in stocks 45% in bonds3

The gradual change in asset allocation over time is often referred to as the glide path. Like an airplane coming in for a landing, the glide path allows your investment to make a gentle landing into retirement by reducing the risk of a crash that could destroy your nest egg.

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Should You Follow The Herd

Just because everybody is doing it doesnt necessarily mean its right for you. As financial advisors are quick to point out, financial situations differ by individual. Are you the right person to snub target-date funds and instead put together your own mix of stocks and bonds?

If your retirement funds are inside a 401, you wont have a lot of choices in most cases, so putting together your own actual mix of stocks and bonds might not be possible. However, you could pick other assets outside of target-date funds.

Target Date Funds Can Be Too Conservative

Research by academics at University of Illinois at Urbana-Champaign and MIT found that, on the whole, target date funds start becoming too conservative for most people around the age of 50.

Using a complicated model, they found that a typical upper-middle class couple without access to family wealth should put 80% of their portfolio in stocks at age 45 and then decline to a steady 60% at and during retirement.

Target date funds, according to the reports authors, do a good job of stock ownership for a whilewith a typical 75% equity allocation at age 50but become too conservate thereafter, with a 50% stock holdings at retirement which then declines to between 30% and 40% in later years.

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Target Date Funds Provide Easy Diversification

Investors who choose Vanguards Target Retirement 2060 Fund get a strong dose of diversification. Here is the funds current allocation:

One fund gives you access to stock and bonds assets, both domestic and international, in one neat package.

The Impact Of Equities Overall And Different Bond Exposures

The returns of equities tend to be powerful enough that their weightings will drive overall returns for a mixed-asset portfolioespecially in strong rallies such as 2018 through 2021 and bear markets like the one in 2022. The disparities in equity weightings in target-date retirement funds show this clearlyand why equity weight is a key consideration for retirees.

We averaged the overall equity weight for each of the 31 target-date retirement funds with five-year histories and plotted those funds’ returns from the beginning of 2018 through the end of 2021 as well as for the first eight months of 2022. Exhibit 2 then groups the category into four segments according to average five-year equity weight.

From 2018 to 2021, funds with higher equity weightings posted higher total returns on average. Those with 33% to 43% equity averaged 7.7% annualized funds with 30% to 33% equity averaged 6.5% funds with 25% to 30% equity averaged 6.3% and funds with 11% to 21% averaged 4.9%. The inverse has also been true, arguably more dramatically. In the first eight months of 2022, those four groups of funds, in the same order, fell 13.2%, 12.0%, 10.6%, and 9.1%. Investors who have little need or desire to risk their capital would be wise to steer toward lower equity in retirement those pushing for higher overall returns must accept the risk of capital losses.

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Set Your Investment Goals

Any good investment plan starts with a good set of investment goals. And by that I mean the personal, lifestyle goals that youre trying to achieve, not some return that youd like to get.

After all, the real goal of any financial decision is to create a life you enjoy. And with investing in particular, taking the focus away from returns and putting it on your personal goals will help you avoid some of the big behavioral mistakes that most investors make.

I would encourage you to explore the idea of financial independence and do your best to define what, exactly, that means to you. With that in mind, you can then start to figure out how much you should be saving and which investment accounts will help you get there.

Those decisions are the meat of your investment plan and will set you up for success no matter which investments you choose.

How Much Does It Cost

Beyond the initial deposit, also consider ongoing fees youll pay. The cost of a mutual fund is known as its expense ratio, an annual fee expressed as a percentage of your investment or, as the name suggests, the ratio of your investment that goes toward the funds expenses. The higher the fees, the more costs can erode total returns.

The average target-date fund had an expense ratio of 0.52% in 2020, according to research from Morningstar. But these fees can range from as low as 0.1% to more than 1.5%, so theres room to shop around. The difference in price often revolves around whether the fund leans on cheaper passive investing strategies or more costly actively managed accounts.

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Save The Date: Target

Planning to retire in 2040? Theres a fund for that. Looking to retire in 2055? There is a fund for that, too.

When investing in your 401 or other retirement savings account, target-date funds, also known as life-cycle funds, are one popular option. You pick a fund that is dated around when you plan to retire, and that fund promises to rebalancethat is, shift the risk profile of its investmentsas you approach that date.

How Does A Target Date Fund Work

Money invested in a target date fund is pooled and then invested into a mix of securities. Riskier assets, such as stocks, initially comprise the majority of the fund’s portfolio. Over time, the mix of securities slowly shifts, with the portfolio increasingly allocated to more conservative investments.

Each target date fund has a “glide path,” which refers to how the fund’s asset mix changes over time. Every target date fund has its own glide path, meaning that the mix of investments changes at different rates among different target date funds.

The two charts below show two different glide paths for target date funds. While their glide paths and the types of assets held differ, both gradually shift over time toward holding more conservative investments.

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The L& g Target Date Funds

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