Yahoo Finance Should You Invest in a Target-Date Fund?
Once maligned and derided, target-date mutual funds were considered the domain of the lazy investor: a place to park your money and wait for it, usually until retirement age. But if target-date funds stirred up all of the buzz of an aging baby boomer snoozing in an Adirondack chair, new evidence suggests they have come a long way in the public eye since their 1994 debut.
Recent statistics point to explosive growth in the category over the last decade, with investment professionals readily recommending them to clients. Morningstar's 2014 Target-Date Series Research Paper shows total fund assets crossed the $600 billion mark last year, a 10.5 percent jump over 2012. In the first quarter of 2014, target-date funds gathered $18 billion in new assets, bringing the total to more than $650 billion, thanks to market appreciation.
"The appeal of target-date funds is evident in those numbers," says Jake Gilliam, senior portfolio manager and managing director at Charles Schwab Investment Management. "They can be a great long-term solution for people who want a highly diversified portfolio and professional investment management, baked in at a relatively low cost," he says.
For the majority of investors, the appeal boils down to this: Target-date funds represent a "set it and forget it" investment strategy. Fund managers do the heavy lifting, while the mix of investments gets more conservative as the target date approaches.
"One of the major advantages of target-date funds is their ability to reallocate over time based on someone's expected retirement date," says Travis Freeman, a partner with Four Seasons Wealth Management in the St. Louis area. "I think they're a positive addition to any 401(k) fund list. Investors just need to know how to use them and need a formal retirement calculation to determine if they are on track for their unique goals."
To that end, target-date fund investors feel more secure, according to a 2014 white paper by Voya Investment Management that surveyed 1,017 employer-sponsored retirement plan participants age 25 or older in September 2013. When asked whether they were confident in reaching their retirement goals, 56 percent of target-date fund participants said they agreed or strongly agreed, compared with 41 percent of those not invested in target-date funds.
That likely has a lot to do with the 2006 Pension Protection Act, which made target-date funds a qualified default investment for 401(k) plans with automatic enrollment, says ReKeithen Miller, a client service manager and portfolio manager with Palisades Hudson Financial Group LLC in Atlanta. "Many companies now use the funds as the default choice for their employees, who often find inertia simpler than making an active decision about their investments," Miller says.
"This 'do it for me' option is a good fit for the vast majority of the population, including defined contribution participants," says Jeff Keller, vice president and director of DCIO sales at Stadion Money Management in Watkinsville, Georgia. "Given most participants are unengaged and thus defaulted, a product that provides an asset allocation strategy with the ability to [change over time] is a great investment vehicle for these individuals," he says.
Target-date funds may also be used in other investment strategies, like 529 plans. "Target-date funds are best used for college funding," says Dan Yu, managing principal of EisnerAmper Wealth Advisors LLC in New York. In this case, the target coincides with the student's projected enrollment date. "Target-date funds within 529 plans are ideal," he adds, in large part because earnings in the college savings plans are exempt from federal taxes, and in many cases, state tax.
Still, target-date funds don't constitute a slam dunk for everyone seeking profit over time.
"You still need to do your research, and there are things you need to consider with target-date funds," says Christopher Tobler, an associate professor of finance and chair of the department of finance at Stetson University's School of Business Administration, located in DeLand, Florida. "First of all, it's a one-size-fits-all philosophy, which may not be appropriate for you. And different investors have different needs and levels of risk tolerance, as do managers, so you need to pick the fund accordingly."
"Investors in these funds typically do not know what they own," adds Jason Pfannenstiel, a founding partner in Mirador Capital Partners in the San Francisco area. "In an equity market correction, for example, the investor may witness a significant decrease in the value of their holdings, liquidate the position out of fear and experience permanent capital loss," he says.
Moreover, it may disturb some clients to know target-date fund managers don't maintain high ownership stakes in the very products they oversee. That points to an apparent lack of conviction in their own investment process, Morningstar reported in the same 2014 target-date fund research report.
"Target-date funds are good in concept but the trouble is, many do very poorly," says Elle Kaplan, CEO and founding partner of LexION Capital Management in New York. "I like the marketing idea behind target-date funds: a one-stop-shop for college planning or retirement. However, many target-date funds have really underperformed," she says.
That said, a September 2014 report by Charles Schwab's Gilliam shows target-date funds displayed less volatility during the Great Recession. While stock values rode a wild roller coaster, target-date funds from Charles Schwab, Vanguard, T. Rowe Price and Fidelity rebounded more steadily from the economic collapse of 2008 and recovered more value through 2012 than the Standard & Poor's 500 index.
"When picking a fund, be sure to look at past performance," Tobler advises. "Not all fund managers are same. Some are stars who consistently meet or exceed the benchmark portfolio, while others are laggards."
In other words, feel free to employ the autopilot approach of a target-date fund. Just make sure the captain of your account doesn't do the same.
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