IT’S YOUR BUSINESS
individual securities and rebalancing their portfolios as retirement nears. On the surface, target date retirement funds appear to be easy buy-it-and-forget-it investments. All the investor has to do is to figure out when he or she expects to retire and buy the fund closest to that date. However, as is the case with most investments, there are complexities and risks associated with target date retirement funds that may not be obvious at first glance.
One of the biggest problems is that many investors simply do not understand how the funds that they are buying work. According to a recent study by financial services giant ING, only 44 percent of purchasers of these funds knew that the allocation is designed to change automatically as the projected retirement date approaches. Of course, this and other important information is contained in the prospectus of every fund, but many investors do not bother to read these documents.
Another issue is that target date funds are unable to take into consideration the needs of
individual investors with widely varying
degrees of wealth and different personal circumstances. Changes in the funds are made solely on the basis of the passage of time and the approach of the projected retirement date. A given fund is managed under the assumption that all of its investors have the same level of risk tolerance, even though this can vary sharply from person to person. Investors may also not be aware that different fund managers and fund families can have very different philosophical approaches. While nearly all managers of target date funds shift their funds’ allocation toward a more conservative investment strategy as the target date approaches, the specific allocations chosen can vary significantly from one manager to another. This is largely due to differing opinions on the importance of equity investments in maintaining better returns versus bonds in producing income.
Because these funds are relatively new, they don’t yet have long- term track records. This makes the task of evaluating them more difficult. For example, the funds can’t be directly compared to equity indexes such as the S&P 500 because they contain both equity and fixed-income investments. Since, in many cases, target date funds carry higher management fees than other investment options, this lack of a track record makes it difficult to tell if those fees are worth it. Since most commercially available target date funds are merely funds composed of other funds, it is possible for an investor to create his or her own target date retirement fund. But that requires deter- mining the optimal allocation between stocks and bonds and decid- ing how that allocation should be changed as retirement approaches. For many people, that depth of personal involvement would likely offset the basic appeal of commercially available funds. Despite some apparent disadvantages, the popularity of target date retirement funds continues to grow. As managing a personal
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