A Target-Date Fund is not a plan

Do financial choices such as investment accounts, advisor designations, stock picks, and more overwhelm you? After all, your retirement lifestyle or your children’s college educations could be significantly diminished if you make bad decisions, right? Analysis paralysis is often the result: our indecision about our 401k or IRA results in doing nothing. Enter the target-date fund, or “TDF”.

Investors view TDF’s as an easy one-size-fits-all solution to the dilemma of selection, allocation, and rebalancing. These funds allocate money to a mix of stocks and bonds according to a pre-set formula, adjusting the blend to a higher percentage of bonds as investors nears their “target” retirement date. The retirement year mix is indicated by the fund’s name, so a “2050” TDF is theoretically appropriate for you if you plan to retire in 2050.

TDF’s became popular when President Bush signed the Pension Protection Act of 2006. By 2014, these funds had grown to over $1 trillion, with over 50% of 401k participants holding some part of their retirement account in a TDF. InvestmentNews predicts that target-date funds will attract 63% of 401k contributions by 2018. So why isn’t this a good idea?

First of all, each TDF creates its own benchmarks. One fund might stipulate investors need a 50:50 mix of stocks and bonds by retirement; another might determine you need 60:40, while a third uses 30:70. Do you really believe that an investor with $2.5 million in a 401k and a paid-off house who retires at age 70 should have the same allocation as a 66-year old retiree with a mortgage, credit card debt, and a $350,000 IRA?

And over the long term, the ease of defaulting to a TDF may come with a high price tag. Most often these funds are created by a specific mutual fund company, using 12 – 18 of their own funds. Rarely do investors take a look at the underlying funds to find what they’re really invested in. If they did, they would often find higher than normal fees and some real dogs. Alas, most investors have been conditioned by the market to be content with any returns at all. What we can’t see (the returns you should be getting), we rarely attempt to measure.

And here’s my biggest complaint with TDFs: they are used as a substitute for real financial planning. Meaning what? Meaning you set aside time to focus on your goals between now and death, calculate the cost, and then figure out if and how you can pay for your goals. Regrettably, most of us spend more time planning a trip for spring break than we do on our financial plans. Now that I think of it, I haven’t run across any one-size-fits-all vacations lately. How does a one-size-fits-all bathing suit sound? I didn’t think so. Then why risk your life savings on a one-size-fits-all mutual fund made up of mystery meat?

So, do you need to pay a licensed financial planner to help you plan? Not necessarily. On the other hand, it will be a lot less expensive than sticking your head in the sand and being hit with the need to work a few more years at age 66. Or having to downsize your home because you bought more than you could afford. Or even telling your 18-year old that he’ll need to work his way through college (although not necessarily a bad thing).

A TDF might be appropriate for you, however, if:

  • You happen to get lucky and pick one that exactly matches your retirement spending plans,
  • You never take any money out except what you need to live on, and
  • You have absolutely no desire or willingness to pay attention to your savings.

Is it really worth the risk to reduce your financial future to a robotic, one-size-fits-all formula? It takes some time and mental elbow grease – whether you pay a professional or do it on your own. If you have analysis paralysis or you’re having second thoughts about your Target Date Funds, my video has some simple ideas for you.

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