Should You Invest in a Target Retirement Date Fund?

November 9, 2009 by  
Filed under Investing, Retirement Planning

Target Date Funds were intended to be a “one-size fits all” retirement investment vehicle. Investors were encouraged to put most if not all of their retirement portfolio into a retirement date fund after selecting a target retirement date. Then, the theory went, they could sit back, relax, and watch as the fund grew over time while automatically adjusting the fund’s asset allocations as their target date approached.

Well, a couple of things went wrong. First, many investors missed the entire point of owning a target retirement date fund and misused them as an investment. Then 2008 happened. Folks who expected that their retirement portfolio would be relatively safe under any market conditions (probably a naive expectation) were surprised to discover that their target date fund valuations dropped substantially. Even the most conservative target date funds (those designed primarily for income) fell 17% on average. Those funds with a longer time horizon dropped by almost 40%.  None of them showed a positive return.

And the saddest news of all was for investors who bought funds designed for a target retirement date of 2010. Those funds (there were 31 of them) produced results that were all over the place. The best 2010 target date fund dropped 3.5%. The worst fell 41.3%. Ouch. Happy Retirement 2010!

I don’t care how young or old you are but if you put money in an investment that is specifically designed for your retirement golden years, you never want to experience declines like that. It is emotionally upsetting to say the least and counter-intuitive to the understood purpose of the fund.

So what happened next?

First, many retirement investors pulled their money out and either went to cash or chose another asset class to invest in. (Sadly those folks who pulled out missed the 2009 mini-rally). This happened just when many mutual fund companies were jumping on the bandwagon and joining the parade of new target date funds.

Second, the domino effect caused some of the newcomer target date funds to surrender to the marketplace and simply liquidate.  (A fund liquidates when it stops accepting new investments, sells its current investment assets, returns the remaining funds pro rata to investors, and then closes down.) According to this report, seven target date funds liquidated in 2008. So far in 2009, fifteen have liquidated. There are probably more on the way, as investors remain wary and disinterested based on the 2008 debacle. There are 246 retirement date funds with fewer than $100 million in assets, which is probably below the sustainable level.

This leaves 80% of target date fund assets concentrated in just three companies: Vanguard, Fidelity, and T. Rowe Price.

So what should you do about investing in target date funds? I would go elsewhere with your retirement money, as I did in 2008. I believe that retirement date funds were an experiment gone bad.

If you like the “set and forget” retirement investing strategy, there are a variety of different “lazy man” and “couch potato” portfolios available to you. Investigate them and pick one that matches two important personal characteristics. The first is your risk tolerance. The second is your retirement trajectory.

Note that a retirement trajectory is different from a target retirement “date” because it takes into account how your employment income may phase out over time instead of perhaps suddenly ending. You may be planning for a phased retirement. If so, your “target date” may not be a fixed date at all.

Finally, remember that when you are investing for retirement, your primary objective is to establish and preserve a stream of essential retirement income. Building wealth is secondary.


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8 Responses to “Should You Invest in a Target Retirement Date Fund?”
  1. My IRA is in a target date retirement fund. I’ve seen a lot of criticisms of them. Clearly you can probably do better if you’re willing to put in the time. Most people don’t properly rebalance their portfolios, though – and if this is the case, target date retirement funds are likely to do more good than harm for those types of people.

    I have another retirement plan (through my job) that isn’t in a target date fund. I also have a pension. The target date fund still comprises the largest amount of my retirement savings. For now, I have a long enough time horizon that I think it’s a reasonable place to keep the money. There are things I’d like to tweak in the fund (maybe too many US stocks) in the future. Thanks for the reminder.

  2. Evan says:

    I don’t think Target Retirement Date Funds are inherently bad. They provide an out for someone who is unable or unwilling to do the research into asset allocation.

  3. kitty says:

    Todd – if retirement funds with target date of 2010 had so much money in stocks to lose 41%, than how could you trust them?

    Additionally, lots of time things don’t go as planned. You may get sick and want your money sooner or you may be “retired” earlier than you plan against your will – baby boomers who laid off now aren’t finding new jobs, not at all. Conversely, you might just find that you don’t want to retire and want to continue working – either don’t want to give up income or just got to a position in which you actually enjoy your work or just feel bored sitting at home or, especially if you are a woman, don’t want to tell people you meet “I am retired”. I’d rather have flexibility.

    If you are young, how do you know how soon you’d want to retire? Our wishes, the way we think, all change as we grow older. When I was 23 I counted on my pension money and was sure I’d work for the same company until retirement, and will retire at 54.5 with full pension and health care in retirement. Than pension plan terms got changed, health care in retirement was gone, then pensions were frozen alltogether. Somewhere along the lines or more precisely during the 90s the promise of employment until retirement was gone too. Still, when I was 40, I was very involved in my work and thought that I’d probably work forever or at least as long as they’ll keep me, and that retiring would be very boring and giving up this nice salary unpleasant no matter how much money I’ll have. Now I am 50, and I think that I’d like to retire in 5-10 years and this income no longer seems that important. But 1) I may be forced to “retire” sooner and 2) if I keep my job, I am not sure how I’d feel in 5-10 years. We change as we grow older and so do our wishes and our circumstances.

    Personally, I’d rather adjust my asset allocation based on the conditions of the economy.

  4. MasterPo says:

    You can’t go all cash or bonds at retirement. You STILL need a good amount of growth in your capital. IMO that’s one of the biggest falsehoods in the whole retirement planning/investing field.

  5. kitty says:

    Master Po – you are assuming that the market will continue to provide that growth for you. But the market is risky. Over the period of 30 years, you might be able to get your money back in a market. But nobody can be sure of what the return will be during the next 10 years. If you are 65, you may just not live long enough to get any kind of “growth” – if you hit a bad period in the market. While one needs to look all the way to the Great Depression to find an over-20 year period with no growth, it’s much easier to find 10 years. Who did you think do better during last 10 years? Do you think you know what will happen in the next 10 years? I sure don’t.

    Additionally, whether or not you need to risk a part of your money, and how much you need to risk depends on your net worth. If your net worth is sufficient that you can live in retirement with low risk investments, than there is no reason to risk any of it.

    I am not saying every retiree should stay away from the market, but he/she should be careful and don’t take more risk than they need and can live with.

    Another thing is that people talk about bonds as if they are risk free low return investments. There are bonds and there are bonds. Junk bonds will give you high return and high risk just like stocks.

  6. MasterPo says:

    Kitty – Clearly you need to reduce your market risk exposure. But you simply can NOT go 100% away from growth.

    The reality is a person retiring at 65 can easily expect to live another 15-20-25+ years. You’re capital MUST continue to grow to keep pace with inflation (I don’t buy for 1 second there was zero inflation in ’09!!!).

    Bonds alone simply will not keep pace with inflation.

    If not for stocks then I don’t know what else to invest in.

    Suggestions?

  7. Funny… just the other day, I was glancing at my 401k portfolio (it’s a fun time to look at those YTDs) Anywho, I did glance up at the target retirement date funds out of curiosity (I have nothing invested in such funds). But I was curious as to how they were shaking out on the upswing. The ones that would apply to me we up, not quite as much as my mix, but they seemed to be doing ok. Others ranged from acceptable to scary (how are you not making money now!?).

    I don’t disagree that these target date funds are probably good for some folks. I’m more interested in a slightly more hands-on approach. Plus I would expect that there is increased fees for the fact that you’re not only paying the fund manager, but the person managing the group of funds as well. Anyone know?

  8. Daddy Paul says:

    Have you ever noticed most target date funds have only the Fund company funds in them? I think an investor is much better off with their own asset allocation. If you do not want to put the work in to do that then invest in a couple of good balanced funds.

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