What Makes Target Date Funds so Bad?
Before I get to the rant I want to note that there are different types of target date funds and I’d like to differentiate the two main types in my discussion. The target date fund that is the main focus of this article is called the “lifestyle” target date fund. I’ll define a lifestyle fund later. The other target date fund I’ll discuss is called the “preserve” fund.
A lifestyle fund starts out aggressive and gets more conservative over time. The fund managers try to provide investors with a steady dose of risk over their lifetime. If you’re thinking this sounds like a good plan it’s probably because it is a good efficient retirement plan and it really is. But what makes a lifestyle fund bad is not the design of the asset allocation. What makes it bad is the fact that the fund managers change their allocation within each fund with the changing market which really negates the whole “risk tolerance” concept discussed earlier.
The preserve fund works the opposite way, i.e., it starts slow and grows more aggressive. This makes sense and by design offers a better risk tolerance profile than a lifestyle fund.
What I’ve Seen With Target Date Funds
Target Date Fund (TDF) is a way to invest your retirement savings into a variety of investments that are supposed to blend in with your age. For example, someone who turns 35 this year would have a retirement date of 2075. So if this 35-year-old invests into a 2022 FT, his or her assets will gradually shift to become more conservative (and assume less risk) every year until the age of 65 when the investor expects to start collecting Social Security and getting more conservative with his or her portfolio.
So why do I hate FFs?
First, I don’t like that it is very easy to lose track of your asset allocation over time.
Second, the fund automatically shifts from aggressive to conservative without the investor taking the time to reevaluate his or her retirement plan.
Again, this will lead to potential losses.
Alternatively, if the investor does not get more conservative with his or her portfolio despite getting closer to retirement, this may also lead to potential losses.
Show Me Some Examples
Target date mutual funds are marketed as golden ticket investment vehicles. They are supposed to take the pain out of investing for retirement. During the financial crisis, they became popular with investors searching for something perceived as safe and simple.
But if you look under the hood of these funds, you’ll find an overwhelming amount of complexity. This complexity can translate to hiding fees, risks and uninvested cash.
The idea behind these funds is that you can choose a fund with a target retirement date in mind and then you don’t have to worry about your investments anymore. You can just sit back and watch the money grow over time.
The long-term average return of these funds is about 7%. But it’s important to note that this is a return AFTER fees. Target date funds are traditionally very expensive to invest in.
The Wall Street Journal does a good job explaining some of the fees you’re likely to pay in this article.
But if you keep reading more about the funds, you’re bound to come across even more fees. Instead of looking like a reliable retirement tool, target date funds start to look like a financial instrument designed for the retirement industry to make money on poor investors.
Managing Your Own 401k
If you’ve never thought about managing your own 401k before, you might be concerned about how difficult it could be. You likely know that there are penalties for withdrawing your money early. There are fees for starting your plan late. And when you have to roll your old 401(k) accounts into your new 401k plan at work, it’s a bit of a headache. Can’t we just leave this money alone and let it be?
For many investors, leaving someone else to manage their 401k is easier, but the reality is that you can do it yourself! Here are the steps you need to take to take ownership of your investments:
Step 1: Get the ball rolling
You won’t have many options for managing your own 401k if you don’t start one. The best place to start is with your 401k plan administrator. Ask for a copy of the 401k plan document so that you can tell if any of the fees are particularly high. Look at the funds available and see if there are more conservative options. See how much you’re paying out for overhead and set a goal for lowering these costs.
Step 2: Make a plan
401k Review Service
Most workers have access to 401(k) plans through their workplace. If you’re in this boat, you’re better off not contributing to your employer’s default investment option, which is likely to contain some high-cost, actively managed mutual funds …
Instead you should be contributing to your employer’s matching contribution to a retirement plan, and you should be shifting your after-tax, non-matching contributions to a low-cost target date mutual fund, such as the one offered by my firm, Cambria.
Why do I like target date retirement funds so much? First, they’re the most appropriate choice for most investors. Target date funds are a way to create a diversified mix of assets that will gradually assume less risk as you near retirement. Choosing a target date fund for the bulk of your retirement accounts portability.
You can take part of your account balance that you’ve built up through your previous and current jobs and transfer that balance into a new job and invest your rollover income in a new company’s target date retirement fund. And that portability really raises the question – how much do people enjoy the ease of rolling money between different target date funds?