Is Your Target Date Fund Safe?
- Despite their popularity, there’s something seriously wrong with target date funds (TDFs). Most are not safe for those near retirement.
- Surveys of beneficiaries and consultants report how safe they’d like to be, but most TDFs are not providing this safety. Is yours?.
- We provide a tool to help you determine if your target date fund is safe. You decide.
If you’re in a 401(k) plan, there’s a good chance you’re invested in a target date fund and that your TDF is one of the Big 3 shown in the next picture:
In a nutshell, there’s a good chance that you will be invested 55% in equities as you enter retirement. This is the allocation that lost more than 30% in 2008, so you know what can happen. The Big 3 TDFs are not safe.
The irony is that participants in TDFs say that 55% in equities is way too risky, and advisors to 401(k) plans agree. A recent MassMutual Retirement Savings Risk Study examines beneficiary risk preferences in 401(k) plans, and reports as follows:
The preferences in the table above can be used as proxies for preferred equity allocations along the glide path. The following graph shows these preferences in contrast to the Big 3 and the SMART TDF Index that we use as our standard for safety.
Consultants agree. Pacific Investment Management Company (PIMCO) has conducted a consultant survey entitled the “2018 12th Annual DC Consulting Support & Trends Survey” that reports the following:
Consultants want TDFs to defend against losses of 10% or more at the target date, and to become even more defensive beyond the target date, defending against losses of 5% or more. These goals argue for very conservative allocations, assuming that the objective is to have a low probability of the indicated loss. For example, a 10/90 stock/bond mix has a 95% probability of protecting against a 5% loss in a year.
In summary, the Big 3 TDFs are not safe near the target date, If you’re in one of these and near retirement, you should consider withdrawing and moving to the safety described in the next section.
What is Safe?
In this section we provide some tools for determining if your TDF is safe, and for moving to safety if you’re not safe. If you’ve defaulted into your TDF, you’ll need to take back control of your investments and move to safety.
Our view of safe allocations at various dates is provided in the graph on the below. Look up your planned retirement age in the table. The table assumes you plan to retire at age 65. If your planned retirement age is different, adjust accordingly. For example, if you plan to retire at age 70 instead of 65, add 5 years to all the ages in the tables.
If you prefer to be more aggressive than our safety standard, you can use the following 2 tables. If your TDF is riskier than the Aggressive level (i.e. off the charts), you are in danger of lifestyle reducing investment losses and should seriously consider withdrawing.