Target dated funds can be beneficial
Let’s discuss target dated funds. They have about $2 trillion invested in them, and they are growing rapidly, especially in 401(k) plans.
Target dated funds are a mixture of stocks and bonds in a portfolio. They may be listed as a year, such as 2030. Because that is 12 years away, they would contain more stocks than bonds. The allocation will change periodically, decreasing the amount of stocks and increasing the amount of bonds as the target date gets closer.
This process tries to automate allocation. Bonds are usually considered the safe part of investment and stocks are considered riskier. Usually, you reduce risk the sooner you need the money. The so-called “glide path” maps the changing allocations.
There are three main indexes that calculate changes in asset mix: Morningstar, S&P and SMART. All produce a little different result. Morningstar, for instance, uses about 10 percent more equities than the S&P. SMART is similar until the “risk zone,” which is five to 10 years before retirement and through retirement.
One challenge is do we go “to” or through.” This raises the question what is the target date? Is it when you first retire or is it hopefully 20 years later, during retirement? There will likely be a lot of inflation during this time. Those time frames would allow for different amounts of risk.
There is an oligopoly of three companies that control a large share of the target dated fund market. Vanguard, Fidelity and T. Rowe oversee about 63 percent of this type of investment. Seven other firms control most of the rest.
The plan fiduciaries try to use these target dated funds to manage investment risk. Hopefully, these accounts will help replace income and cover longevity risk. In fact, running out of money during retirement is normally listed as the No. 1 fear of retirees. Many people, however, have not saved enough to safely fund retirement. Taking on more risk to try to make up for a shortfall can be dangerous.
For all of the modeling and projecting these target dated funds utilize, the income is not guaranteed. If the market goes up enough, it will work out fine. If we experience anything like the beginning of this century, it could be troubling.
Many people are probably exposed to a high level of risk. The market is not having a great year, although it is up a little. It is ignoring tariffs and everything else that could upset it. While the economy is stronger than it has been for a number of years, it is pretty fully priced.
Target dated funds do not protect you from sequential risk. This is when there are market losses right before or right after you retire. Someone will be affected by this risk; you just don’t know who. Someday the market will correct.
It always does. Believing this will never happen is a pipe dream. The market will recover after the correction. It is a matter of how long it lasts for anyone who is starting retirement during these down times.
Complicating this situation is bonds will not be the safe haven they have been during the past 15 years. As interest rates rise, bond values will reduce. As the Fed uses other tightening actions to control the economy to regulate inflation, bonds will be negatively affected. The extra bonds that target dated funds invest in will not offer total protection for your portfolio.
Make sure you consider all types of assets and not just target dated funds for your retirement portfolio. They might be part of the solution, but will not necessary protect you from all risk.
Gary Boatman is a Monessen-based certified financial planner and author of “Your Financial Compass: Safe passage through the turbulent waters of taxes, income planning and market volatility.”
To submit columns on financial planning or investing, email Rick Shrum at rshrum@observer-reporter.com.