Are Target Retirement Funds Too Risky?

by Kevin on May 5, 2009

I came across this article on target retirement funds over at CNN Money’s website that got my wheels turning. The basic premise is that one size fits all investments like Target Retirement funds are sometimes too risky for the average investor.

Seeing how we have everything except my 401k invested in Target Retirement funds my ears perked up a bit at this idea. Well, that’s an understatement, but you get the idea.

First, an overview.

What’s a Target Retirement Fund?

Here’s a very brief overview of a target retirement fund. A regular mutual fund only focuses on one type of investment. If your mutual fund tracks the S&P 500 that’s all that it does. To get a well diversified portfolio you would need to add additional mutual funds that covered bonds and international stock indexes.

Along comes target retirement funds which are essentially a fund comprised up of other funds. Think one large basket with various mutual funds inside of it. With Vanguard you only pay the target retirement fund’s expense ratio (rather than the basket costs plus the cost of all the underlying funds).

The Target Retirement part points to where you choose the year you want to retire. As you get closer to retirement the basket of funds moves things to a more conservative stance — that is you hold more bonds and cash-like investments than ultra-risky stock investments).

The Benefit of Target Retirement Funds

Generally speaking I think target retirement funds are a genius idea. It equates to a one stop shop for your basic retirement needs. If you choose a date far into the future your portfolio will be more stock-heavy. This is more risky, but with risk historically return follows.

The opposite is true as well. If you pick a close retirement date then the allocation of funds within the portfolio will be less risky (more bonds and/or cash-like investments).

Another benefit is you can get started with a small amount of money. With Vanguard you can invest in a well diversified portfolio for $3,000. (If you picked individual funds you would need $3,000 for each fund. That adds up fast if you’re trying to diversify.) Of course as your portfolio grows and you put more money into the market this may become less important, but for starting out it is a real benefit.

The Downside of Target Retirement Funds

There is one big ultimate risk you take with a fund of funds like this. You give up control of your asset allocation.

For many people this may not seem like a big deal. You’re trusting your investment decisions to the professionals, right? That is true, but nonetheless you give up control. If your personal situation changes the all-in-one fund may not be the best fit.

The article at CNN Money notes that recently some of the target retirement funds had far too large an exposure to stocks for their designated age group. The article blamed the fund companies.

While I can see that argument I believe the real fault lies with those investors. They should read the prospectus (or at the very least do a Google Finance search) to identify how the fund is invested, and how it will invest in the future. All of these funds show how they start in terms of allocation (stocks versus bonds/cash) and show where they are going. There isn’t much hidden from view.

Are All-in-One Funds Too Risky?

Personal responsibility is important in all areas of life including your investing. Don’t trust anyone — including me! — blindly. Do your own research, read the facts given to you, and make your own decision.

We stay on top of our investments. I’m aware of how they are allocated and I understand our timeline.

For us, for now, target retirement funds make sense.


SaveBuyLive May 5, 2009 at 6:52 am

I’m not a big fan of target retirement funds because you can pretty easily mimic the same asset allocation using much lower cost index funds or ETFs and regular rebalancing.

That being said, target retirement funds provide pretty much everything that the average person could want in a retirement package (growth, diversity & rebalancing). They aren’t perfect but they are a lot simpler than trying to pick funds individually. Especially if you are confronted with a list of some 300 funds and don’t know much about financial stuff.

You may give up asset allocation, but if a target date fund encourages you to start saving for retirement, that’s better than nothing.

PT Money May 5, 2009 at 8:37 am

Good article on Target Date funds. I like them, and think as long as you’re not paying too much in expense and you understand what your risks are, they are a good idea. I use one in my company 401k.

I think a lot of the 2010 and 2015 funds weren’t conservative enough for a lot of people and they saw some big neg hits this past year. I think this press by CNN is just a reaction of the current market and a reason to make a headline.

At the end of the day, like you say, it’s up to you to know your risk. If you can’t stomach a 40% decline when you’re not even retiring for 20 years, then just go get in bonds and cash. Know your risk level.

MLR May 5, 2009 at 4:50 pm

For most people I think target retirement funds are perfect.

You CAN match the asset allocation and performance with lower expenses in other ways. The problem lies in the fact that most people won’t rebalance as necessary. Luckily for them, these funds do that automatically.

I am actually considering converting my 401k over to a target retirement fund so I don’t have to continuously rebalance. We’ll see!

MoneyEnergy May 5, 2009 at 9:33 pm

I’ve been hearing lots about these types of funds recently, and I have to say I know little about them, but the little I’ve heard I’m not sure I like. I guess I prefer to have a bit more control over my investments than these allow. I don’t think one-size-fits-all applies very much in investing. Also, seeing how so many financial managers treated many people’s plans over the last two years, I’m not sure how these would fare any better.

Kevin May 16, 2009 at 6:48 pm

@SaveBuyLive: That’s pretty much how I see it. We could pick our own funds/ETFs, but I really don’t think that is necessary until you have a decent sized investment account growing. That is, picking a handful of ETFs and paying multiple broker charges for small amounts of money being put into ETFs.

Not sure if that made sense — what I’m saying is if you have $3,000 the target retirement funds get you not only invested, but invested with diversity. Rather than buying 4-5 ETFs and paying broker charges. If you had $25,000 then the broker charges are pretty small in comparison to the amount being invested.

@PT Money: Any time you invest you’ve got to be aware of how the things you are invested in are really invested. Yea it’s sad those funds were stock-heavy, but people need to read their prospectuses!

@MoneyEnergy: I see these as a good starting point. All of our Roth IRAs are in these simply because they are diversified and we have a long time horizon. I’m not sure I would use them close to retirement, but for us they get us some international exposure in a simple manner.

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