Target date funds have grown in popularity in recent years, often appearing in 401(k) plans that hope to promote retirement planning among employees. The simplicity of the funds are their biggest selling point. You know how old you are. You know when you are likely to retire. So you pick the fund that corresponds with your retirement target date.
But the very simplicity of making that choice creates an illusion, according to critics.
“Our experience shows funds with the same target date can have significantly different asset allocations,” Mike Palmer, CFP, Managing Principal, Ark Royal Wealth Management, wrote in Kiplinger.
Four people with the same retirement date can wind up with four very different target-date funds in their retirement plan. Returns among those funds will vary, and the unsophisticated investor can make the wrong choice. At issue are the same things that often hurt investors: a lack of financial knowledge, high fees, and a reluctance to engage in due diligence and research.
Complicating matters is that young investors are the most likely buyers of target date funds. People with less than two years at a job use target date funds at 57%, while only 36% percent of people with 30 years on the job chose such funds.
The key for wealth managers may be to help clients see the wisdom in looking at other investment options once the retirement plan builds some capital. Sophisticated approaches such as tax harvesting, for example, are not available in target date funds. In addition, longer lifespans suggest that the more cautious approach of target-date funds may not be the best move as people age.
“As I’m getting closer to a retirement date, the fund is selling stocks buying more bonds. Just because the calendar turns a page doesn’t mean I should automatically become more conservative,” Chris Chaney, a vice president at Fort Pitt Capital Group, told the Pittsburgh Post-Gazette.
Roughly $1.5 trillion is held in target date funds, according to the Investment Company Institute 2020 Fact Book.