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Taking a balanced view of target date mutual funds

Sarasota Herald-Tribune logo Sarasota Herald-Tribune 8/30/2021 Robert Stepleman
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Target date funds are generally viewed as both useful for many investors and overhyped as panaceas for all investment problems related to retirement; counterintuitively, both are true. This is because many investors are looking for a simple hands-off solution and mutual fund companies are willing to oblige.

One of the challenges for investors is balancing return vs. volatility. When a young investor is saving for retirement, not withdrawing from his portfolio, and with decades to recover from market “crashes,” a 100% equity portfolio can make sense. However, when this investor is near or in retirement and withdrawing from the portfolio, the issue is more complex.

A “target date” mutual fund could be helpful for investors looking for a simple “set and forget” solution to this issue. Unfortunately, target date funds’ strategies can be flawed. Before studying why, let’s review the basics. Target date funds contain a mix of asset classes: equities, fixed income, cash. They shift the investor’s asset mix to more “conservative” each year as the investor gets closer to his target retirement date. This means increasing the percentage of the fund’s assets in fixed income.

What happens in real markets? Morningstar’s research shows target date funds designed for retirement in the years between 2000 and 2010 lost an average of more than 30% from peak to trough in 2008-09. They performed better when the market dropped 34% last year; the average target date funds dropped 10%.

A key determinant of their long-term performance is their “glide path.” This is the algorithm that governs the rate the fund becomes more conservative, and its asset allocation in retirement. Current target date funds have two issues: There’s no agreement on the “correct” glide path. They don’t adequately protect investors from a market crash in the crucial period from five years before retirement to five years after. This is because target date funds rarely have more that 40% in bonds during this critical period. Then after this period they fail to decrease bond holdings enough to provide adequate growth.

Thus, current glidepaths do a poor job of balancing two key retiree risks: sequence of return and longevity. The first is the risk stock returns will be negative in the five years preceding or after retirement. Then, even if the stock market does better, after five  years of withdrawals there might not be enough left of the portfolio to carry the retiree through retirement. The second is the asset allocation after retirement may be too conservative to provide the growth necessary to meet retirees’ lifetime needs.

Research by Wade Pfau and Michael Kitces suggests more optimal glide paths ramp down stocks to 10%-30% at retirement and then start increasing the stock holding gradually to 50%-60%. Their research indicates this type of glide path can provide better protection against sequence of return and longevity risks.

Then, does an investor need a current target date fund?

A study by “Research Affiliates” may provide insight. They simulated one common glide path over 141 years and found an investor using a 50% stock and 50% bond allocation, and regularly rebalancing would likely have had better results.

All data and forecasts are for illustrative purposes only and not an inducement to buy or sell any security. Past performance is not indicative of future results. If you have a financial issue that you would like to see discussed in this column or have other comments or questions, Robert Stepleman can be reached c/o Dow Wealth Management, 8205 Nature’s Way, Lakewood Ranch, FL 34202 or at He offers advisory services through Bolton Global Asset Management, an SEC-registered investment adviser and is associated Dow Wealth Management, LLC.

This article originally appeared on Sarasota Herald-Tribune: Taking a balanced view of target date mutual funds


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