Target date retirement funds are a popular choice (often a default choice) for many defined contribution retirement plans (e.g. 401k, 403b, 457). These funds highlight their “glide path”, smoothly transitioning the investor from equity holdings (higher volatility) to bond holdings (lower volatility). All based on our age. This seems sensible. Until you dig just a bit deeper.

Question: what exactly do we want a target date fund to do? Accumulate value before retirement? Provide income in retirement? I think many people want it to do both. The question is, how well does it do one or the other, or both? Let's stop for a moment and consider this. We'll probably work (accumulating) for 35-40 years. On average we'll be retired (decumulating) for 20-25 years.

Let's talk about the accumulation phase first. We'll look at the decumulation phase in the next article. Here's an important point. How much you save when you are young is more important than the investment strategy. It takes most people quite a bit of time to save a meaningful amount of money when you start from zero. It's only after you've built up your savings, usually 10+ years, that it really begins to matter what the investment strategy is. Because its at that point that the return from investing begins to affect the account balance. A 10% gain or loss on $10,000 is $1,000. A 10% gain or loss on $500,000 is $50,000. At the later part of your working years, the total amount of potential gain or loss becomes increasing important. The last five years of your working life could see your retirement balance double! Or, conversely fall by 50%..... A big gain is a huge win. But, a big drop can completely derail your retirement plan.

The critical (and I mean negative) attribute for target date funds is that they don't adjust for anything happening in the markets. They just blindly transition allocations from equity to bonds whether it makes sense or not. That's the fundamental weakness for target date funds. Their “set it and forget it” glide path is oblivious to the present environment. When you're young and just beginning to accumulate money most target date funds work just fine. But, when you have finally accumulated a meaningful amount of money your investment risk has increased. To be clear, this has nothing to do with your tolerance for risk. Rather, it has all to do with your capacity for risk (loss).

It's fine to use a target date fund early in your working years. However, you can not be complacent once you've accumulated a meaningful amount. You need to become more deliberate.

Next up, what about target date retirement funds in retirement?

It seems like pitches for timeshares come in waves. You get mail and robo calls one month, and don't hear any pitches for perhaps several months. Then you get the pitches again. Its a game of marketing. It's crucial that the pitch hit you at just the right time. If you are constantly getting pitched, you easily develop a defense to it. But, when its been awhile and you happen to be thinking of how and where you could get away... that's when you're vulnerable. People ask me whether a timeshare is a good investment. If you listen to the pitches, it's the best deal ever... and right now! Hmmm. Not so fast.

It turns out that timeshares can be a good investment for some people, and a lousy one for others. One thing is for sure. The time to determine that isn't during a “free” visit that accompanies most pitches. Like many financial decisions there are two facets that should align. One is personal, that is, how will this meet your needs and expectations? There's a lot to consider in this. The second is cost, that is, how much am I paying for this experience. We usually factor in the entry cost, but don't accurately factor in the exit cost. Here's a tip. If you're considering a timeshare, take the time to investigate the secondary market. You know, the one where existing owners are trying to sell their timeshare. You may be amazed at the discount from original price. (you may also be surprised how many are up for sale).

Most of the time a timeshare should not be considered an investment. Instead, it needs to closely align with your personal interests. After that it's a matter of accurately assessing the costs both going in and getting out.

At some point as people get older they begin to consider just how will the assets they accumulated be distributed to their heirs. Most people have a will (though there are those that don't for one reason or another). They may also rely on beneficiary designations on their retirement accounts. This is a pretty straight forward way to convey many assets. But often we need to consider situations that aren't so straight forward. For instance, what about second marriages when there are kids from the first? Or, what if we are concerned with a young persons ability to properly handle (a bundle of) money?

The desire to avoid probate is probably the most common reason people consider a trust. There are a variety of good reasons to avoid probate. It takes time (sometimes a lot of time, like a year), incurs a tax on the value of the property, and finally is likely the last thing your executor wants to deal with given the situation (your death), and so people often hire a lawyer for the process (more expense).

If you own real estate out of state, then a trust can be very useful. Real estate generally has to be probated in the state where it is located. So, if you live in MD or VA, and own beach property say in DE or NC, that means separate probates in your home state and the state where your beach property is located. A trust can bypass this probate process.

While there's a lot to know about trusts, their advantages and drawbacks, it also isn't so complex that most people would benefit from exploring the topic further. If you have questions about trusts, give me a call or send me an email. I'm happy to talk with you.

Most retirement calculators use average returns for various assets (like U.S. Equities, bonds, etc.) in order to calculate future values for investments. It's common to project investments for 30 years or more when doing retirement planning. This can lead to a huge mistake. It's one thing to conclude from a thousand simulations that a particular strategy will be successful, and another to recognize that the retiring person only gets one shot at their life in retirement.

That's why it's important to understand that there are risks in the sequence of market returns over that retirement lifespan. Actually, there are two risks. One is called sequence of consumption risk, excessive spending early in retirement. The other is called sequence of returns risk, poor returns early in retirement. Both have the effect of decreasing the retirement savings with long term detrimental consequences.

It turns out that sequence of return risk is particularly onerous for retirees. You see, that's when you've accumulated a lot of money. So, a major market downturn at or near retirement has a big effect on you. Not so for the young who hasn't been accumulating for 30 plus years. Incurring a major market downturn early in retirement dramatically reduces the probability that your savings will meet your retirement projections.

The point is to be aware that the use of average returns is often misleading for individuals. The strategy of just buy and hold regardless of what happens in the market is fine if you're young. But, can have grave consequences if you're a retiree. BTW, a target date retirement fund doesn't do a very good job protecting you from sequence risks. Just ask those retirees with a 2010 fund.

There are good ideas for addressing this risk. These include being tactical, not fixed in your investment mix. Having alternative sources of income outside of investment accounts. Consideration for pension like annuities that don't rely on the market. Of course, being willing and able to cut your consumption makes a difference.

If you've been an aggressive saver during your working years, it's probably going to be a challenge to be a spender in your retirement years. In fact, there's a pretty good chance you'll leave an estate that is as large as your savings were at the start of retirement. I think there are two forces at play that affect this situation. The first one is that we will probably want to spend the same amount in retirement as we did when working (let's say the last 10 years of working). But, if you've been a good saver it's likely that you are also a person(s) that value the accumulation of wealth. And that's why you may struggle to spend your savings in retirement.

Sometimes savings is directly related to funding a specific retirement income goal (an amount per year for some number of years). More often I think we save without knowing how much to save. The problem with retirement is that we don't know how long we'll live, and we don't know if and when we might be faced with a large expense (likely medical). So we spend cautiously. That's not a problem if we are truly enjoying our lives, or we have a goal to leave an inheritance. My sense is that many people don't have a good perspective on their spending guidelines. The point isn't to spend it all and then die. Conversely, it also isn't to save it all then die. My advice.... go get guidelines on how much discretionary spending you have. Guidelines should provide you reasonable probabilities for discretionary spending amounts in retirement that considers longevity and medical variables. You can still determine how much to save and how much to spend. But, importantly you'll have an idea of where you stand.