Most of us who have participated in an at-work retirement account have most likely put some, if not all, of our money in a target-date fund, or a TDF. In fact, according to PLANSPONSOR, 81% of plan sponsors offered target-date funds as of 2020. SmartAsset also reported that by the end of 2018, 56% of plan participants had money allocated to a TDF. TDFs have become an essential component of most retirement plans and a go-to option for many. With many of us having a significant bulk of our net worth in retirement accounts, it is important to take the time to match our investment elections to our goals. Although TDFs are a practical, blank approach, some of the objectives and strategies of these funds can come up short when tailoring an investment portfolio to an investor’s retirement needs.
But before we dive in any deeper, what is a TDF? In short, TDFs are mutual funds or exchange-traded funds, also known as ETFs, that follow an investment timeline targeting a specific year. For example, a TDF with a target year of 2045 will start shifting assets into more conservative vehicles until a bulk of the assets are concentrated in traditionally conservative investments at the fund’s target year. A target date of 2065 might hold an allocation of 90% stock and 10% fixed income, while a fund with the target date of 2023 might have an allocation of 30% stock and 70% bonds. The exposure to higher risk investments in the stock market correlates with how far out the target year is. There are also variations of target date funds, such as glide path, collective investment trusts or managed accounts. Depending on your retirement account type and design, all or some of these options may be available to you. In all, these vehicles are intended to be a one-size fits all approach and are not specially tailored to any participant’s individual needs.
So why might your target date fund fall short of your needs?
- TDFs are HUGE
According to MIT Sloan School of Management, TDFs total assets increased from $8 billion in 2000 to $1.4 trillion by the end of 2019. By comparison, a report from the Bureau of Economic Analysis said that represents 6% of the total US GDP in 2021. The sheer size of these funds makes them less nimble, and a traditional portfolio tool, such as rebalancing, could take months to be implemented. Additionally, unexpected in and outflows of assets could cause the managers to buy investments at a premium or sell at a discount in order to meet the cashflow demands. This goes against what many call the number one rule of investments: buy low and sell high.
- Not all 40-year-olds share the same goal
Let’s take, for example, two men named Dan and Jay. They both turned 40 this year, and they both use their retirement account’s default investment options of TDF 2049. Jay started saving earlier and has a significant nest egg which allows him the opportunity to retire at 60, or in 2042. Dan sees himself working until 67, or 2049. Knowing how TDFs shift assets as the target year is approached, Jay might be better off building a custom portfolio or considering a TDF with an earlier target date. With a target date seven years past his estimated year of retirement, he might take on additional and unintended market risk by taking a more aggressive approach.
- The company running the TDF
How does your TDF work? That depends on who manufactures your TDF lineup. TDFs are usually offered as a family in at-work retirement accounts. This means that your employer is usually going to stick with the same company for all of their TDF needs. Additionally, a collective-investment trust, target-date fund and glide-path fund all function differently, although they have the similar objectives. To add to the layer of complexity, some managers are known for being more aggressive than others. Regardless of your thoughts about a particular fund family, you’re typically locked into the options offered by your plan.
- Lack of customization
In working with clients of all backgrounds, we have come to find out that some clients have personal preferences when it comes to investments. Some might lean more towards socially responsible investing, lean less toward international markets or be less inclined to invest in certain market sectors. The inability to exclude certain securities that are less favorable because of the sheer fund size may also inhibit investors from participating in market upswing and trends.
If not TDFs, what is the alternative? This is where Sun Valley Financial comes in. Using professional money managers and a robust infrastructure, we are able to help our clients navigate the world of investments. No two plans are the same, and for that reason, Sun Valley Financial can help individual participants make the most of the retirement plan through a self-directed brokerage account, otherwise known as an SDBA, or by making the most of the core-fund lineup. By working closely with our clients, SVF can tailor a client’s portfolio to their specific needs. SVF specializes in working with participants who have balances in their at-work retirement account. Most of these assets are forgotten as “set-it-and-forget-it” savings plans, but they require the same attention that any other investment account receives.
From asset allocation to trading to rebalancing, SVF can ensure that your accounts are constantly under watch.
The information provided covers a broad spectrum of strategies and is not meant as specific advice. Make sure you contact your tax and financial professional and, of course, do your proper due diligence.
If you’d like to contact us, you can reach Sun Valley Financial in Scottsdale and Phoenix, Arizona by calling 602.960.0362.