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Target Date Funds: Simple May Not Be Ideal

August 3, 2018—Employers are increasingly offering Target Date Funds (TDFs), in their company retirement plans. I understand their appeal. TDFs manage themselves and are easy to understand. They’re turnkey portfolios that start with a prefab mix of stocks, bonds and cash; they then automatically shift toward an increasingly conservative, 20% stock/80% bond & cash “target” allocation by a particular year.

You pick your TDF based on the year you plan to retire. So, if you plan to retire in 2045, you’ll select a 2045 TDF. The rest of the decisions are made for you over the years, leaving you with a highly conservative portfolio that’s (in theory) all set to fund your retirement at just the right time.

This makes them a huge improvement over wading through piles of funds to guess what’s best for you. But TDFs aren’t perfect. For example, how can the 2045 fund be right for everyone retiring that year? If you’ve saved more than enough to fund at least 25 years in retirement, a conservative, 20%/80% portfolio might work. But if (more typically) you need your savings to keep earning decent returns through your retirement, you will likely end up cursing your “simple” decision.

I’ve been describing “to-retirement” TDFs. A “through-retirement” TDF takes longer to reallocate your holdings, so you may be holding 67% of your portfolio in stocks when you retire. The fund continues to reduce your stock exposure over the next 5–30 years until it hits its target allocation.

Which is better: “to” or “through” funds? It depends. Either way, instead of TDFs, I typically prefer plans with flexible, well-built model portfolios. They’re still easy to use and understand. They let you select an initial allocation, and then modify it based on your own personal financial needs as they change over time. You will have much more control over the ultimate investment outcome. That will almost always be better than being locked into somebody else’s prescribed, extremely conservative, target.

Bottom line, be aware of the subtle but important differences among "to" and "through" TDFs, as well as model portfolios, so you can choose accordingly. And if your plan doesn't offer model portfolios, you may want to request them.

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