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Own a Target Date Fund? Know the Risks

The concept behind target date retirement funds (TDRF) is pretty brilliant. Select a year that you expect to retire, buy the TDRF with that year in its name (for example, the Vanguard Target Retirement 2045 Fund), and then sit it back and let it do its work. These low-cost funds, which are now featured in a broad array of 401(k) and 403(b) plans will slowly shift their holdings from stock funds to bond funds as you age, reducing risk. 

With more than $1.1 trillion now invested in these funds (according to the Investment Company Institute), TDRFs might seem like a no-brainer choice. And they are, if you are making investment selections on your own and have little comfort with picking among different bond and stock funds. 

But for many advisors, myself included, TDRFs are too blunt an instrument. While it’s important to develop a portfolio strategy that sheds risk over time, there are too many other variables to consider for this one-size-fits all approach. Every client of mine has different needs when it comes to dependents, risk tolerance, life expectancy (due to family health history) and the availability of other assets in their financial plan.

A TDRF that will “mature” in 2035 or 2050, for example, with the bulk of its assets invested in stocks funds, and a minority of assets in stock funds, can be problematic. For younger investors with a very long time horizon, know that risk equals reward and you should be in a position to let your nest egg grow for a very long time and shouldn’t really be thinking about bond funds. So any TDRF is problematic for you.

For those close to retirement, the opposite is true. TDRFs lost a lot of their value in 2008, creating heartache for many imminent retirees, due to their stock exposure. For them, a more tailored risk strategy would have been ideal. 

I have no problem recommending sizable investments in TDRFs to clients when we sit down to make choices in their investment accounts. But I also work in other investments to ensure even greater risk-and-reward optimization than this one-size fits all approach can deliver.