Target-date funds were introduced in the early 1990’s as a simpler way to invest for one’s retirement. Target-date funds seek to diversify risk by investing in a mix of equities and fixed income, and these investments are broad, typically including international exposure in both markets. The ratio or mix is rebalanced as years elapse and the investor nears retirement. For example, a 20-year-old investor would have a target-date of 2065 assuming his goal was to retire at 65 years old. The portfolio mix at 20 would most likely include more equities than fixed income, let’s say about 70-75% in equities, which over time would be expected to produce greater returns than fixed income, but also have a greater potential for large losses than fixed income. As the investor ages (let’s assume he reaches 50 years of age), then that portfolio would be expected to have been reduced to about 45-50% equities and the remainder in fixed income. Consequently, as the investor reached retirement age, the portfolio would then be more conservative, with a lower return profile, but a greater degree of certainty that the funds he needs at retirement are there.
According to Bloomberg, U.S. investors in the $1.4 trillion of 401(k) plans that utilize target-date funds for their retirement may be surprised at how exposed their funds are to equities, and thereby the degree of losses they have in their portfolio in this medical-led market fallout. Some of the biggest providers of target-date funds held 45-55% in stocks in portfolios geared to retire in 2020. In addition, further research indicates that even in the fixed income portion of the portfolio, funds were invested in European bonds, of which some had negative yields. The bottom line is that just like every investment one makes, continued management and due diligence is the most important aspect of the process. The models that are used to create these portfolios only look backwards, never forward. Some markets require both, especially in the fixed income markets.
Investing in target-date funds can be likened to purchasing pre-packaged food products. Most of us will look at the ingredients to see what is in a package. Some people are allergic to peanuts, others may be on a low-salt diet, or are diabetic and therefore are cognizant of the amount of sugar that can be consumed. Reading the ingredients is extremely important. The same should be done for one’s retirement investment portfolio. Having the ability to research or discuss the investments with one’s financial advisor is central to knowing that at retirement age, the funds required are there. Target-date funds were a creation to help the small investor diversify; however, we should not ignore those investors by allowing computer models to make investment decisions without understanding the investor. Knowing your customer is an ingredient that should never be ignored and unfortunately, target-date funds never invest in this ingredient.
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