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Missing the Target

Mark Eckman  |  November 27, 2019

USE THE RIGHT TOOL for the job and you’ll get the best result. If you need to connect two boards, you could use a hammer and a nail or a screwdriver and a screw. Either methods work—and they’re certainly better than banging in a screw with a hammer, which I’ve seen tried. It was not effective.

Participants in 401(k) plans, alas, display similar behavior with target date funds, or TDFs. A TDF offers a diversified portfolio in a single fund, with the mix of stocks and bonds changing as you approach retirement. When used correctly, the fund’s asset allocation should be appropriate for your age—aggressive while you’re young and becoming more conservative as you age. There’s no need to trade or adjust the mix. The fund does that automatically. The evidence, however, suggests many people use TDFs incorrectly.

Vanguard Group found that 52% of 401(k) participants have invested in a TDF, making the funds a popular choice for retirement money. But it seems many folks don’t stop at one fund. Morningstar studied TDF users and found many also invest in other funds—sometimes another TDF and sometimes other funds offered in their 401(k) plan. Result: These additional funds change the retirement saver’s asset allocation, so it may no longer make sense, given the employee’s expected retirement date.

Indeed, as a plan administrator, I’ve seen participants hold as many as 12 TDFs. Some participants have told me their financial planner recommended buying multiple TDFs. What can I say? It sounds like another case of using a hammer with a screw.

But what if you don’t like the risk profile of a particular TDF? Morningstar recommends you choose a single fund with a target date closer to today if you want a more conservative portfolio or, alternatively, a date further away if you want something more aggressive. In other words, you don’t need to own more than one fund to adjust your risk.

Check with your 401(k) plan’s administrator to find out how the plan uses TDFs. Many plans automatically enroll you in an appropriate TDF when you become eligible to contribute, unless you choose an alternative. Some plans may, by default, also deposit company contributions in a TDF. Don’t want to own the default TDF? You can probably change the fund selection with a few clicks of your mouse.

Mark Eckman is a data-oriented CPA with a focus on employee benefit plans. His previous articles were Alphabet SoupFinancial Pilates and Giving Voice. As Mark approaches retirement, he’s realizing that saving and investing were just the start—and maybe the easy part. His priorities: family, food and fun. Follow Mark on Twitter @Mark236CPA.

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BenefitJack
BenefitJack
1 year ago

To hannahkaz: The problem is that Vanguard, Fidelity and others have allocations to equities > 50% for individuals who are in a 2020 fund. So it was in 2008/2009 with regard to 2010 TDFs. Target Date does not mean the year in which you will stop working. It is meant to be the year you commence payout. Unfortunately, the big three who have the greatest amount of assets under management using target date funds are competing for added monies, so, they tend to have higher equity allocations and make tactical allocations designed to improve their reported investment returns.

The better alternative is a V shaped equity allocation as individuals near retirement, reaching the nadir at the target date, then increasing the equity allocation in anticipation of post-retirement inflation.

To Mr. Eckman/Dick/others: The challenge here is simply that plan sponsors/service providers/advisors often deploy target date investments incorrectly. When making a target date investment available, the plan should structure it so that it applies to all plan assets. This would avoid individuals making investments within the plan that might conflict. That is, if the individual thinks that the target date investment is not “diverse” enough, the plan should force her/him to make their own investments.

This challenge is why I favor Target Date Models – where the target date investment is not a specific fund, but a set of no-cost, fully transparent electronic investment directions that allocate assets across the underlying Core investment options. Typically, you get the same result (glide path, landing point, etc.) at less cost, where participants have a
much better understanding of the actual allocation. For example, when the account is re-balanced (annually, quarterly to lower the equity allocation as the individual approaches the target date), the participant is notified of the re-balancing as it is a transfer among the underlying Core options. So, in such a program, there is no opportunity for tactical allocations, nor is there any competition to spike rates of return.

Where individuals have other retirement monies, such as in another plan or an IRA, as they approach retirement ages, they should consider managed accounts.

R Quinn
R Quinn
1 year ago

Good points. When I managed a 401k that was a ongoing problem. I don’t think there was one person who used the TDF as intended. Ironically, by using a TDF plus index funds employees thought they were diversified. IMO the greatest challenge in retirement planning (after getting people to save) is to get them to select funds in their retirement plans. I once tried to help a relative and at the time he was in 23 funds, most just different by the fund manager.

mark236
mark236
1 year ago
Reply to  R Quinn

Agree. We lead horses to water, but…

hannahkatz
hannahkatz
1 year ago

Keeping all your retirement in a TDF makes sense when you are younger. But my experience in 2008, when I was doing just that, let me watch VTWNX fall off a cliff, just like virtually all equity and allocation funds, only to recover nicely since then. However, if I had to make RMDs when the NAV was way down, it would have been painful. So now as I approach RMD world, I have some conservative bond funds in the same account to allow me to withdraw funds without pain, even during the next recession. I know some advisers would frown on this, but I sleep better at night because of it.

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