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The Pros and Cons of Target Date Funds in Retirement Planning

Posted by Seton McAndrews | CFP®, Vice President Investments
February 28, 2018

the_pros_and_cons_of_target_date_funds_in_retirement_planningTarget date funds have been around for over 20 years, but over the last several years they have seemingly become a mainstay of 401(k) plans. For novice investors and those just starting out, the ‘target date’ feature of choosing a retirement date and “setting and forgetting” an investment strategy has understandable appeal. But for investors with larger amounts of assets under management and more complex financial situations and retirement needs, target date funds may not do the trick.

Below we’ll explore some of the positive features and drawbacks of target date funds.

What are Target Date Funds?

In principle, target date funds sound like an ideal retirement strategy. A target date fund generally aims to achieve a specific outcome. For example, a person may have a goal to retire by the year 2027, or a goal to minimize volatility. Or perhaps the investor wants to maximize the possibility of creating consistent income in retirement. Again, all wonderful sounding, easy-to-implement solutions.

And for some investors, target date funds can indeed be effective solutions. For novice investors who are just getting started in saving and retirement planning, a target-date fund can be a useful option to get a portfolio immediately invested in a diversified allocation and to let it run on autopilot. Typically, target date funds are automatically rebalanced and reallocated over time.

Another advantage for a relatively new investor is that since he/she may not have the resources (or the need) to hire a financial advisor, a target date fund could potentially address the investor’s core needs at an early stage, which is to ensure the portfolio is aligned with long-term goals and risk tolerance.

When Target Date Funds Become Less Effective

As an investor accumulates more assets over time and starts to approach retirement, target date funds may not offer the most effective, comprehensive solutions. There are a few reasons why:

  • Many target-date funds are funds from one company, which means you may not be getting the top managers in each asset class. A manager may have a great large-cap growth strategy, for instance, but be lackluster in international or small-cap categories.
  • Investors generally must give up control over where to overweight and underweight their investments, and if there is a particular sector (like tobacco or oil) that an investor is averse to investing in, there may not be an option for avoiding it.
  • Target date funds often operate under the assumption that the investor does not have any other retirement accounts. In that sense, the funds sometimes fail to take a holistic view of someone’s financial situation, meaning that the assessed risk and portfolio allocation of the target date fund may not actually meet the client's needs or retirement goals.
  • A particular ‘target date’ may match the date you want to retire, but that does not necessarily mean the actual asset allocation in the fund is as conservative or aggressive as suits you.
  • Target-date funds may give the investor a sense that they’ve done all they need to do in retirement planning. If only retirement planning were that simple!¹ It’s still important to review portfolio allocations each year and to adjust an investment plan for shifting goals and needs – not to mention planning for retirement income and setting up an estate plan.

Not Everyone’s Situation is the Same – Get Customized Advice from WrapManager

Target-date funds attempt to be a one-size-fits-all solution to investing. But not everyone's financial situation is the same, and at the end of the day retirement planning is more complex than just investing in one fund. WrapManager works with each client to develop an investment plan based on your goals and objectives, and we rarely work with only one fund or money manager. To learn more about how WrapManager can go beyond target date funds in helping you build a retirement plan, please call one of our Wealth Managers today at 1-800-541-7774 or start a conversation over email at wealth@wrapmanager.com.

 

Sources

CNBC

financial planning Retirement Planning Saving for Retirement Retirement Income Strategy

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