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?
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?
RSS Feed