3 Reasons Target Date Funds May Miss The Mark

It is easy to see the appeal of Target Date Funds. Savers can plop their money into one fund – usually a diversified mix of stocks, bonds and other assets – and as their pre-picked date of retirement nears, the fund ratios automatically reset to a more conservative asset mix to presumably shield them from risk.

Target Date Funds have increased in popularity over time, particularly in 401ks. Vanguard, which manages a good chunk of the $4 trillion in US 401k plan assets reported in a study of its clients’ investment patterns that now, over 25% of its clients had their entire 401ks invested in a single target date fund. 

But is easy always better? 

Here are some of the limitations of Target Date Funds that every investor needs to consider:

1. One-Size-Fits-All Might Not Fit You.

The reality is that the typical Target Date Fund looks at only one criterion: when you plan to retire.  It does not take into account individual circumstances including personal risk tolerance, current wealth, other assets, current income and even expected income in retirement.

While the assumption that savers should move to a safer, less volatile strategy as they near retirement is generally valid, it can’t be the only tenet guiding an investment strategy.  

2.  Target Date Funds are Not Transparent?

“People pick target date funds because they  are easy to use, but most don’t really know what’s inside,” says Craig Birk, Vice President of Portfolio Management for Personal Capital.

With Target Date Funds, the details can be in the fine print –  or sometimes, not available at all.  A recent investigation into the transparency of target date funds found that most target date funds in 401ks are “fund-of-funds,” and do not actually report the underlying securities.  That makes it even harder to know what you’re actually investing in.

But you can do some research to find out what is inside your fund and its allocations.  Otherwise, it will be difficult to tell if your investment strategy is actually appropriate for you.

3. Target Date Funds Are Expensive

We’ve written at length about excessive mutual fund fees (see this article on The Seven Deadly Investor Sins).  Target Date Funds are on average more expensive than mutual funds.

According to Morningstar’s Target Date 2013 survey, the “weighted-asset” average fee for Target date funds was 0.91% in 2012, versus 0.77% for mutual funds.  If that fund is in a 401k plan, there are probably other administrative fees that you’re paying on top of that.  And that can end up costing you in retirement.  

The Bottom Line.

Target Date Funds can be a step in the right direction in terms of creating diversified portfolios for investors that rebalance to become more conservative over time.  But you might be able to do better, especially if you can find a financial tool or an advisor who can customize your strategy to meet your goals.  “You can usually create a better portfolio on your own,” says Craig.

So what should you do?  Take a look at what’s in your Target Date Funds to make sure they work for you in the context of the rest of your financial picture.  Try free software, such as Personal Capital’s Investment Checkup to see how well-suited your funds are for you, and how much you’re paying for them.