Target date funds (also known as life cycle funds) are increasingly popular vehicles for investment and retirement planning. They are mutual funds or ETFs which shift asset allocation between stocks, bonds and cash as a certain date, usually expected retirement, approaches. Generally, they get more conservative as time passes.
There is nothing particularly wrong with target date funds, and for many people who would otherwise make poor decisions, they can be a good tool. But most people can do better.
At Personal Capital Advisors, our Personal Strategies are essentially sophisticated target date funds. Instead of following a blind path for asset allocation, however, they incorporate individual goals and several specific factors to determine each client’s personal asset allocation. Also, our Strategies utilize individual securities to create diversification and tax advantages not possible with the passive index funds most target date funds use.
Most target date funds have reasonable allocation plans. A major concern, however, is they are too conservative in later years. Most allocate 50% or less to stocks at retirement. Most people still have a time horizon of over 30 years when they retire, especially if they are married. The sub-asset class mixes of most target date funds are generally reasonable, and most incorporate some small cap exposure and some international exposure.
Most target date Funds have fees similar too or slightly higher than the fees of the underlying mutual funds, usually between 0.5% and 1.5%. The Vanguard and iShares ones are a bit lower, and are the leaders in target date funds for good reason.
For people with both retirement accounts and post-tax accounts, there may be benefits to placing certain investments in one or the other. Most notably, REITs and High Yield bonds should be held in retirement accounts. Target date funds eliminate this flexibility.
There was a lot of scrutiny about Target date funds in 2008 because they lost money. This is ridiculous. They are designed to hold high equity allocations. Target funds should not be considered “safe” investments. They are simply tools to help with asset allocation over time.
For people with limited investment experience and/or limited discipline to stick with an appropriate asset allocation, target date funds can be a simple and acceptable solution. However, most people can do better by creating a custom solution and implementation plan.
Those who use target date funds still need to look under the hood and understand what the asset allocation looks like so there are no surprises. Different fund families use very different allocations.
Craig Birk, CFP®
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