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Target Date Fund Risks

I like target date funds, a.k.a. target retirement funds. (More precisely, I like Vanguard’s target date funds. Every other fund company charges too much. In fact, according to Morningstar, the next-cheapest provider charges more than three-times what Vanguard does.)

With just one fund, you get all of the following:

  • Diversification across the three most important asset classes: domestic stocks, international stocks, and bonds.
  • Extremely broad diversification within each of those asset classes, and
  • Automatic rebalancing, so you don’t have to worry about it.

Not bad!

But target date funds have their flaws too. And this last week was a perfect example.

The Risk of Target Date Funds

Vanguard recently announced that they’ll be increasing the international allocation of their target retirement funds from 20% of the stock portion of the portfolio to 30%.

This isn’t a huge change. And I’m inclined to say it isn’t a bad change either. (In fact, it puts the portfolios closer to what I’d usually recommend.)

But it is a change. And unless you’re paying attention, you wouldn’t know about it.

And therein lies the danger: The entire point of target date funds is that they’re for investors who don’t want to pay attention to their portfolios.  They want a hands-off, automated solution.

Doing Your Homework

Before investing in a target-date fund, it’s absolutely essential to check its current asset allocation as well as its glide path (that is, the way in which the fund will shift its allocation in the future).

But that’s not enough. The glide path described in the prospectus is not a contract. The prospectus may tell you that, ten years from now, the fund will have X% of the portfolio in bonds, but that’s not necessarily true. Any time between now and then, the portfolio manager could change his/her mind.

In short, target date funds are actively managed mutual funds (even though they may be super-low-cost and composed of index funds). There’s somebody at the helm making decisions about what allocation the fund has.

The takeaway: Target date funds are a low-maintenance approach to investing, but they’re not a no-maintenance approach. Be sure to read any communications you receive from your fund company, and be sure to check your fund’s allocation on a regular basis to minimize surprises.

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  1. An investor can do all the homework they want regarding target date funds. They have performed poorly in the past, present, and in the future. There is no transparency for the average consumer regarding this product. I am not sure how an investment advisor or financial planner could sleep at night recommending a target date fund to a client. Costs associated with ETF Index funds = DIA, SPY, QQQQ – will get you to the same place. The costs are cheaper and the ability to move in and out of the ETF are very convenient.

  2. Have Vanguard target retirement funds performed any worse than the funds that make them up?

  3. Vanguard’s target funds don’t have a long enough history to make such a judgment, IMO. If they add no more expenses than the underlying funds, however, I don’t see that they are worse choices. On the other hand, we have access to Fidelity’s Freedom funds in our 401(k), and I thought the overlying fees too high.

    Off topic, but it’s also worth pointing out with respect to Vanguard that they are lowering their minimum requirements for the lower-fee Admiral shares on a lot of their index funds. They also plan to add North America (i.e., Canada) to the Total International Index.

  4. Mike excellent post. I agree with much of what you are saying. While Target Date Funds offer several advanatages, they are essentially once size fits all. Further I fear that many participants lull themselves into a false sense that investing in a TDF will ensure that they reach their retirement goals. A far better approach is for plan sponsors to offer their participants access to qualified advisors who will provide unbiased, unconflicted advice. (full disclosure I am in the process of launching a business to do just that)

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