5 Reasons Target-Date Funds Are Not Equipped For Retirement Assets

Morningstar recently identified the BlackRock LifePath Index funds as The Best Target-Date Funds for 2021 and Beyond.

At a quick glance, these funds faired ok during the 2020 meltdown compared to the S&P 500.

However, there are 5 Reasons Target-Date Funds Are Not Equipped For Retirement Assets

  • Your target-date fund could very well be under-allocated to stocks when you hit retirement. When it comes to asset allocation, not all target-date funds follow the same principles. When selecting a withdrawal date, some funds utilize retirement age as a guide, while others anticipate life expectancy. It is a minor distinction, but one that should not be disregarded.
  • Target-date funds cannot account for outside assets.

    This is the most important issue to consider when it comes to asset allocation in retirement: While the greatest target-date fund can perform admirably throughout your working years, once they reach the goal date, certain funds will stop adjusting their asset allocation. When the portfolio deviates from the target, the manager’s responsibility is simply to rebalance it. Others will continue to increase their bond allocation.

    If you keep your target-date fund, you may become overweighted toward the fixed income asset class since you can approach Social Security similarly to an income-producing asset like bonds.

    Apart from your age, there are additional elements to consider when it comes to asset allocation, and target-date funds can’t account for these because they don’t know about your specific financial demands in retirement. Your asset allocation should be managed across assets, you cannot rely on target-date funds to get you there.
  • The DOL has five main issues with the TDFs. In short, for each plan, the plan fiduciary must:
    1) Know if the TDFs chosen, have the ability to get defensive in market failures.
    2) Establish an objective process for comparing, selecting, and reviewing the TDFs.
    3) Understand the fund’s investments and how they change over time.
    4) Determine if the expenses are appropriate for the services given.
    5) Develop effective employee communications.
  • The major risk associated with target-date funds: failure of diversification. As stated by T Rowe Price authors, Sébastien Page, CFA, and Robert A. Panariello, CFA, in their paper, When Diversification Fails, “One of the most vexing problems in investment management is that diversification seems to disappear when investors need it the most.” They add that “To enhance risk management beyond naive diversification, investors should reoptimize portfolios with a focus on downside risk, consider dynamic strategies, and depending on aversion to losses, evaluate the value of downside protection as an alternative to asset class diversification.”
  • There is a latent risk associated with target-date funds that have to do with large losses.

    There is a very important reason that Warren Buffet’s “first rule of investing” is also the second rule: it takes a lot of gain to make up for losses. This graphic highlights a key lesson of investing.