Mutual funds are “baskets” of assets that provide diversification for investors so that they don’t fall prey to “having all their eggs in one basket”. For instance, a mutual fund could hold shares of ten different pharmaceutical companies, eight different oil and gas companies and three different beverage companies all at once. Also possible is a fund that holds s mixture of CDs, stocks and bonds. The thinking is that if something is going down in value, something else may be going up in value.
Target-date mutual funds are a subset of mutual funds that allocate investments across asset classes like cash, stocks and bonds and assign a retirement date to the fund based on the risk and return prospects of the mix of securities. Looking at a basic risk continuum, cash is least risky to hold, bonds are moderate risk and stocks have the most aggressive risk properties of the three asset classes. As retirement gets closer for each target-date fund, the asset allocation changes gradually to move away from more growth-oriented, riskier assets like stocks to more moderate, safer assets like bonds and cash. First introduced in the early 1990s, according to Wikipedia, these mutual funds have gained a great deal of popularity, especially in retirement accounts like 401ks, 403bs and profit-sharing plans. In the latest data covered by Forbes, it was reported that in 2019, 87% of company retirement plans offered target-date plans and over 60% of company employees hold at least one target-date plan in their retirement account.
There are definitely some benefits to target-date funds. The greatest is their simplicity: pick your target date, find a fund with that date in its title and then check it off your list and forget it. The assumption is that you let the fund worry about asset allocation as you get closer and closer to your retirement date and you don’t need to worry your head about re-balancing or choosing different investments to mirror your different circumstances as age and get closer to the end of your working life. A great many people are intimidated by choosing funds for their retirement account dollars. Target-date funds make sense to consumers and are easy to understand.
On the other hand, the “one-size-fits-all” approach of these funds is their biggest downfall. Not every employee who is going to retire in 2030 looks the same: some have significant other means of support outside their retirement account, some are two-earner households while others are not, some have dependents who are going to require more household income after retirement…the list of unique personal circumstances goes on and on. One investor with a large 401k balance in a target-date fund may be in great shape for retirement, but another may need a more growth-oriented bent to his or her account in the years prior to their end of work life. The latter person is not going to be well-served in a target-date fund that steers them into cash and bonds in the last chapter of their work period and perhaps should be, instead, in a fund or funds that are going to be more aggressive. The bottom line is that a point in time is too general a goal to really reflect the particular needs of an individual investor.
Target-date funds are “funds of funds” and are composed of a mixture of individual mutual funds offered by a particular fund family. Their very nature could also reflect some “cons”. One is the possibility of higher expenses. Mutual funds all have an expense ratio which is an annual expense of the fund company to pay the investments team, keep the lights on, send out fundholder mailings, etc. Being a fund of funds, target-date funds’ expense ratios are the sum of all the underlying fund fees. That may or may not be higher than other funds, but you should know what that metric is. Also, since a fund family chooses all the underling funds included in the target-date instrument, you won’t have the freedom to pick the best stock fund from one family and the best bond fund from another family and the best real estate fund from a third family. The funds are chosen for you and you run the possibility that you will probably not be getting “best in class” across the board.
Would you like to have a conversation about your retirement plans? I’d love to make myself available for a complimentary meeting. Please call 563-949-4705 or email [email protected].
Securities offered through J.W. Cole Financial, Inc. (JWC) Member FINRA/SIPC. Advisory services offered through J.W. Cole Advisors, Inc. (JWCA). Huiskamp Collins Investments, LLC and JWC/JWCA are unaffiliated entities.