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Target date funds (TDFs) have similar risk until they approach their target date, which is intended to be your retirement date — typically age 65. Risk at the target date ranges from 20% risky assets to 90% risky assets, with most in the 90% group. There are 2 groups — safe and risky.
So what is the “right” level of risk for those near retirement? Academics have addressed this question extensively, and their answer is “very safe”, like 80% risk-free.
Most TDF providers say they follow this academic theory that views total wealth as a combination of human and financial capital. But they don’t actually follow the theory. They’re 90% risky at the their target date. They say they follow the theory but doing so is less profitable than the high risk they actually take.
What do you think? Do academics have it right? They use lots of math to develop their recommendation. Or do fund companies have it right? You won’t find math to support their approach.
High risk has won the performance horse race for the past 15 years. That will change, and this time 75 million baby boomers are in the Retirement Risk Zone when losses could ruin the rest of life. It’s like “airplane risk” but the odds of it happening increase every day that the stock market goes up.
Very important and well-articulated article. As you suggest, the low vs. high risk choice is more complicated than it may at first appear. Considerations include (but certainly don’t exhaust) risk tolerance and capacity, health and passive vs. labor-intensive income—does the retiree want to work part-time? Ninety percent risk is too vulnerable to sequence-of-return risk for my taste, but just 10%-20% could leave you at risk of running short on cash late in the withdrawal phase. My guess is that for most a balanced portfolio (60% stocks, 40% bonds) would make sense. I feel comfortable now at a relatively high risk rate (80% stock ETFs) because I am fortunate to have other non-correlated investments and passive income, and over the years have become better able to tolerate risk. Even so, my 80% is invested quite conservatively and may, in the end, not differ much in volatility from a 60/40 split invested more aggressively.