Aiming For Bull's Eye With Target Date Funds

The concept is straightforward: A target date fund is a mutual fund providing a mix of assets—such as stocks, bonds and cash investments—designed to meet investment goals at some future “target date,” such as when you plan to retire. Such funds are similar to lifecycle funds, in that both tend to reduce the risk of their portfolios as time goes by. But with target date funds, there’s a big bull’s eye looming in the future.

With professional fund managers handling the nitty-gritty of choosing investments and making adjustments for target date funds, they may appeal to employees participating in company-sponsored retirement plans as well as to business owners, plan administrators, and other fiduciaries. For the most part, you can just sit back and track the results while the fund managers do the hard work.

However, the devil is in the details. If you’re blissfully going about your business and not paying much attention to your target date funds, as either an investor, a fiduciary, or both, you could be in for a rude awakening when the target date arrives. Investors in these funds learned painful lessons during the stock market downturn of 2008 and early 2009, and to avoid similar problems, employers and employees need to look for funds that are designed, under optimal conditions, to 1) avoid losses, and 2) maximize gains without jeopardizing asset preservation.

Target date funds that aim to achieve these two objectives will most likely adopt a comparatively defensive stance. That could include putting more of a portfolio into Treasury Inflation Protected Securities (TIPS) and regular Treasury holdings than would be the case for the asset allocation mix of other such funds. (TIPS are tied to fluctuations in the Consumer Price Index, and when the CPI rises, the bond principal increases proportionately—thus boosting the payout to investors.)

Another important aspect of these funds is that you need to think of the target date as the landing point for the fund’s “glide path”—the key part of the formula it uses to determine how and when assets are allocated. Typically, the glide path alters a fund’s holdings to make the overall portfolio more conservative as it approaches its target date. Looking at a fund’s glide path, rather than simply its target date, lets you consider whether that fund’s particular characteristics are a good fit for your needs.

When examining a target date fund’s glide path and overall objectives, there are several important factors to consider. Here are suggestions to guide the way.

  • Asset allocation is critical—and different funds with the same target date may have very different allocations, both during the glide path phase and when they arrive at the target date. One fund, for example, might still have a majority of its assets in stocks, even at the target date, while others may have much more conservative portfolios emphasizing bonds and cash. If you’re looking for funds that focus on preserving principal, especially as the target date nears, their portfolios should reflect that objective. 
  • Diversification within different asset classes is another crucial aspect. The more broadly each allocation is spread, the less likely a fund will be jolted by the specific risk of volatility in a particular asset. The stock and bond portions of a portfolio could include a variety of domestic as well as international holdings.  
  • Carefully selecting and monitoring target date funds is particularly important if you are a fiduciary offering the investments to employees. Plan participants have initiated lawsuits against fiduciaries that failed to meet  the required standards of conduct. 
  • Cost still counts, so when considering target date funds, factor in administrative expenses and tax complications that could siphon away assets needed for retirement. For you and your employees, it’s what’s left in the account at the end of the day that truly matters.

If you choose a fund that arrives at its target date in good shape, that’s still not the end of the story. People who are in good health these days may live as long as 30 years in retirement, so target date funds need to be viewed as a stepping stone, rather than as your final destination.

This article was written by a professional financial journalist for Phase 3 Advisory Services, Ltd and is not intended as legal or investment advice.

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