Should I consider investing in Target Date Funds with later target dates?
I look at my retirement accounts every couple days even though I do not plan to touch them for several years. I have my current employer's 401(k) Plan that I receive a match on, a Roth IRA and a Traditional IRA. My Traditional IRA has holdings in a 2050 Target Date Fund. With people both living and working longer, should I look into investing in a Target Date Fund for 2055 or later? What are the benefits and possible risks involved with these funds?
You bring up a great point. If I use a target date fund (almost exclusively in 401k plans) I generally use the date which lines up with the clients needs and estimated retirement. This is opposed to the typical "when will I be 65" choice. Many target date funds end up with more bonds in the portfolio than I think would be appropriate for many peoples portfolio.
DAVID RAE, CFP®, AIF® is a Los Angeles-based retirement planning specialist with DRM Wealth Management a Registered Investment Advisor. He has been helping the community reach their financial goals for over a decade. He is a regular contributor to the Advocate Magazine, Investopedia and Huffington Post as well as the author of the Financial Planner Los Angeles Blog. Follow him on Facebook, or via his website www.davidraefp.com
In my opinion target date funds are not a good choice. Once you get out past 20 years for the target date these funds are nearly 100% in stocks. I have not fund any that have long term performance better than a pure index like the S$P 500. The big problem is that I find most people think their money is being managed in these funds and they really aren't, at least based on my definition of "managed". In the past two major bear markets, 2000 - 2002 and 1997 - 1998, the longer dated Target Date funds had losses comparable to the S&P 500 (about -50%). And even shorter dated funds had losses far too large for investors nearing retirement.
While not as exciting you could focus on dividend paying stocks, reinvest the dividends and take advantage of compounding. By 2055 you should have built a nice income stream from dividends alone to retire on. One ETF that I like is NOBL which invests in the dividend Aristocrats.
I use NOBL frequently in client accounts.
Target date funds are a getting strategy to start with your investing. The date on the fund is your projected retirement date so funds you choose with a date close to today, the fund will have more fixed income and conservative holdings. So if you are an aggressive investor, I would choose the highest target date fund available. I believe they release new options on an annual basis so you may not find a 2070 for a few years. As you review your account on an annual basis, you could choose to update your current and future contributions into a new target date fund with the farthest date from today which means you should always be investing aggressively.
Target date funds can be a relatively simple way to accomplish the goal maintaining a well balanced portfolio that both re-balances periodically and adjusts (decreases) risk as you age and grow closer to retirement. There are a few potential issues, however, with these types of funds. There are no strict rules or guidelines that govern what allocation is appropriate at each age (length to retirement) and many different funds that have similar target dates have different allocations. You can either determine on your own or discuss with a professional what a correct current allocation is comfortable to you and adjust to the target fund that matches that mix. Alternatively, many fund families offer different fixed allocations, (conservative, balanced, agressive, etc.) you can use one of those. Either way you should stay updated and make periodic adjustments depending on your ongoing situation and as you age. One potential pitfall of target date funds, and a reason I tend to avoid recomending them for things like college planning (529s) is that the timing of market declines (which are inevitable) may be compounded as a fund can allocate away from riskier (potentially higher returning) assets during a pullback making recovery more difficult.
Target Date funds allocate their investment based on your estimated retirement age. The funds with target date further in the future will have a substantially higher allocation in stocks as they expect you to tolerate more risk. As the fund approaches the target date, it will start gradually decreasing its allocation to stocks and increase its allocation to bonds. Therefore reducing the risk of the investment.
That said, I strongly recommend that you check the current allocation of the 2050 and 2055 fund before you make any decision. My guess is that they would be very similar if not identical. The difference will probably become more apparent further in the future. You could compare the 2020 and 2025 funds from the same family,
The main risk with target date funds is that they assume your risk tolerance based on your age. It's a fair assumption, however, your individual circumstances could be completely different.