A few years back, target date funds were all the rage in retirement accounts like 401(k)s, 403(b)s and they spilled over into individual retirement accounts like IRAs as well. The selling point was the following: You could simply “set it and forget it” and the fund would do all the work.
How Target Date Funds are Supposed to Work
The way the funds are supposed to work is that they ensure that the asset allocation mix is appropriate for the desired withdrawal timeframe. In other words, if you’re 35 and plan on retiring at 60 (in the year 2035), you might put all your money in a 2035 retirement date fund which would be heavy on stocks given the lengthy duration until planned withdrawal. Conversely, if you have a substantial amount tucked away in a 529 plan for your kid’s college to be starting in a couple years, you might have had it in a 2015 plan which would be heavier on cash and bonds and have very little or no stock exposure.
Why You May not be Getting What you Expected
While you may have been expecting very low volatility and guaranteed returns for short-dated funds, you may actually end up with a substantial loss, like retail investors learned all too well during the recent market downturn. In 2008, while the S&P Target Date 2010 Index dropped by 17% (which is bad enough), the Oppenheimer 2010 fund dropped over 40%! Many investors were caught completely off guard to learn that even with something as conservative as it gets in their mind, they still got walloped. Even Treasury bonds can lose value when funds leave that asset class and move to another like we saw later in 2009. As the risk trade came back on, investors exited US Treasuries and went back into stocks, so even investors in the much vaunted “bond safe haven” lost money. And short-dated target funds usually have a very high percentage of holdings in such bonds.
What Are You Getting for your Money?
The final straw in the Target Date Fund debacle is that the fees are very much higher than other investment options including ETFs or doing it yourself. Companies have justified the fees due to the amount of holdings and rebalancing required to perform the “hypothetical” strategy of a perfect balance over a given time, but given the relatively low returns in the safe options combined with the high fees, there’s a pretty substantial loss of capital over time just based on the fees alone. Tack on the low gross return due to conservative holdings and before you know it, you may actually be losing purchasing parity due to inflation.
Does all this mean you shouldn’t use target date funds? Not necessarily, but you definitely need to do your homework. Investigate just what you’re getting for your money, how your funds held up during the recent downturn, how the allocation is balanced and whether you’d be better off just doing it yourself by shifting more money into cash (money market, savings, CDs or whatever “guaranteed” vehicles you have at your disposal) over time.