The Lure and Lunacy of Target Date FundsAccording to a recent research paper by Vanguard (How America Saves 2019, 401(k) Statistics), an overwhelming percentage (77%) of retirement account investors utilize target date funds in their 401(k)’s. The lure of target date or lifestyle funds is to provide investors a simple, diversified approach for a specified retirement date. The reality, however, in many instances, is these funds make it difficult for investors to sustain their lifestyle, including inflation, for the balance of their lives.

The primary culprit in the target date funds approach is what fund companies call the “glide-path.”  This entails ever-decreasing stock market allocations as you move closer toward retirement. In fact, Vanguard uses the phrase “less risk through broad diversification” to describe their approach. It seems that the word “risk” is used to describe volatility when actually, the primary risk for retirees is the double-headed monster of running out of money and failing to keep pace with inflation.

Solving the Retirement Equation

Many target date funds reflect stock allocations in the range of 40% or less at the target retirement date and these allocations usually decline until they settle around 20- 25% a few years after retirement. That relatively low allocation to stocks may comport with what investors think they want (because they are over sensitized to day-to-day market volatility), but these allocations are unlikely to solve the retirement equation for most families.

The Vanguard research referenced earlier also points out that a majority of investors (52%) have their entire retirement account invested in a single target date fund. While that may indeed be simple, it likely is simply wrong.

It’s Impossible to Predict the Future

The governing principle of financial planning is to align resources to reliably meet your particular long-term objectives. The whole “glide-path” approach is designed around what the fund companies think investors can handle emotionally in terms of volatility. However, investing for retirement is unlike investing for any other purpose because it’s impossible to know precisely how long you’ll need the money. While the average retirement timeframe is around 20 years, you can’t plan for the average. You might live 25, 30, or even 35 years past retirement. What then?

Can You Handle the Truth?

In the pivotal scene from the 1992 film A Few Good Men, Jack Nicholson’s character, Colonel Nathan Jessup, yells “You can’t handle the truth!”

You Can't Handle the Truth

It seems like the fund companies are doing just that in their structure for target date funds. The truth is the stock or risk allocations are too low for most investors and they know it but surmise something is better than nothing.

Most investors will need significant (more than 50%) allocations to stocks for the remainder of their lives in order to offset the impact of living cost increases. Start there. Ready for a real conversation?

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