Why Select a Target Date Fund?
Target Date Fund assets have grown from next to nothing in 2006 to approximately $2 trillion at the end of 2018. In the next six years these assets are expected to more than triple to more than $7 trillion by the end of 2024.
What is a Target Date Fund (TDF)
A traditional Target Date Fund is a mutual fund with one major difference – it has an expiration date.
The event date is also known as the target date. For example, you plan to retire in 2035 The target date of the mutual fund is the year you plan to retire.
- A person in their working years is accumulating assets in a Target Date Fund
- This person’s target date is 2040 (the year he or she plans to retire)
- The Target Date fund manages that person’s assets under the assumption that the investor will retire in 2040, and begin withdrawing some or all of the investments.
Target Date Funds use “glide paths” to automatically reduce risk over time as investors age and approach their target year (2040). Using 2040 as an example and the current year is 2019, people who invest in the 2040 fund have 21 years until they require the assets or distributions from their assets. They can afford to take more investment risk now when the target date is 21 years away then they can later when the target date is a few years away.
The Target Date Fund, like other mutual funds, pools assets for the purpose of investing them in the securities markets. This means everyone in the fund is invested the same way even though there may be significant differences in circumstances and goals.
This one-size-fits-all strategy is a serious weakness of Target Date Funds.
As the fund approaches its event date, it automatically becomes more conservative to reduce the risk of large losses at or near the target date.
How They Got Started
Target Date Funds were originally used to accumulate assets inside college savings plans. In this case, the target date was the year a child left for college.
The child’s parents used the Target Date Fund to accumulate assets for tuition, books, and living expenses.
Retirement Savings Plans
It did not take Wall Street long to realize there was an even bigger market for Target Date Funds – retirement assets in 401k plans. Propelled by the Pension Protection Act (PPA) of 2006, Wall Street packaged their customary mutual funds into fund-of-funds that followed glide paths that reduced risk through time. The PPA declared 3 qualified Default Investment Alternatives (QDIAs) that fiduciaries could invest in on behalf of participants who could not make an election. TDFs are by far the most popular choice of QDIA.
This was an attractive market because plan participants were responsible for making their own investment decisions and many of them were uncomfortable making these decisions – they did not have the requisite knowledge, time, or interest, so their employers choose for them.
Target Date Funds have mass appeal because all the fiduciaries had to do was determine the year the participant wanted to retire (usually at age 65). The Fund did everything else.
$7 Trillion by 2024
This was a homerun for the financial service industry because 401k plan sponsors and their participants liked the simplicity of the one-decision-investment-process that was provided by the Target Date Funds.
Other Retirement Assets
Millions of people have changed jobs and rolled their 401k assets into IRAs. In an ideal world, they could continue to invest their roll-over assets in a Target Date Fund. Like the 401k plan, the target date of the fund is the year they retire.
Millions more have retired and they also rolled their 401k assets into IRAs. A target retirement date no longer works for these retirees. But, that might be a little short-sighted due to rising longevity. What if these retirees had a target date of 100 years of age for both spouses? They could still benefit from a Target Date Fund investment strategy. Their event date is end of life.
TDFs in Retirement
Virtually all TDFs have a constant 45% equity allocation in retirement, and pundits have begun to question this ‘Decumulation’ strategy, especially in light of the fact that there are now 75 million Baby Boomers. Research shows that a much different glide path works best in retirement, namely starting retirement very safely to protect assets, far less than 45% equities, and then gradually re-risking to extend the life of assets.
Is There a Better Way?
Target Date Funds have a lot of appeal based on their ease of use for investors who want an investment service that automatically adjusts to their declining tolerance for risk.
On the other hand Target Date Funds have limitations because they are mutual funds that pool peoples’ assets for investment. What if there were Target Date Funds that did not pool assets for investment? What if people could have their own Target Date Fund?
GlidePath Wealth Management provides Target Date Funds that are tailored to the needs of clients. GlidePath does not pool clients’ assets for investment. The target date could be sending a child to college, retirement, or age 100 for both spouses.