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Robert Powell's Retirement Portfolio

Aug. 17, 2022, 11:16 a.m. EDT

Why target-date funds may be sabotaging your retirement

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By Robert Powell

If you’re like most of the 30 million or so people investing in a target-date fund mutual fund inside your retirement account, you’ve likely adopted a set-it-and-forget-it attitude toward your nest egg.

That would be a mistake.

Consider the findings from two recently published research reports.

In one report, New Evidence on the Demand for Advice within Retirement Plans , the authors examined whether defined-contribution plan participants seek out advice with respect to their asset allocation, savings rate and the like.

And what wrote Jonathan Reuter, an associate professor of finance at Boston College’s Carroll School of Management and David Richardson, the head of the TIAA Institute, discovered is this: Some workers saving for retirement in a 401(k) plan seek out advice but not those who invest in target-date funds (TDFs).

“Advice seeking increases with age, account balance, annual contribution level, web access, and changes in marital status,” wrote Reuter and Richardson. “More provocatively, participants who invest solely through target-date funds—the dominant default investment option—are significantly less likely to seek any form of advice throughout the age distribution, raising the possibility that reliance upon defaults crowds out advice seeking.”

Said Reuter in an interview: “It gives me some pause that what’s happening is a loss of engagement.”

And if you set your target-date fund and forget it, what’s going to happen, said Reuter, “is your circumstances change (and) something that may have been a good initial investment may no longer be a good investment. And over long periods of time, that’s problematic.”

In the second report, researchers at Morningstar’s Center for Retirement & Policy Studies found that many 401(k) plans offer off-the-shelf target-date funds designed for participants staying in their retirement plan “through” their retirement even in cases when a plan participant is more likely than average to roll their money out of their plans.

“This mismatch is important because these ‘through’ glide paths typically take on more risk than ‘to’ retirement glide paths, leaving participants with more equity exposure than they would have if their glide path accounted for their propensity to take money out of the plan at retirement or separation from employment,” Lia Mitchell, a senior analyst at Morningstar, and Aron Szapiro, head of retirement studies and public policy at Morningstar, wrote in their report, Right on Target? Plan Sponsors May Not Always Consider Participants’ Behavior or Needs When Selecting Target-Date Glide Paths .

According to Finra , “a ‘to retirement’ target-date fund will, generally, reach its most conservative asset allocation on the date of the fund’s name. After that date, the allocation of the fund typically does not change throughout retirement. A target-date fund designed to take an investor ‘through retirement’ continues to rebalance and generally will reach its most conservative asset allocation after the target date. While these funds continue to decrease exposure to equities throughout retirement, they may not reach their most conservative point until the investor is well past age 65.”

The upshot of the two reports is this: Target-date funds are fine for young workers who are just starting to save for retirement in a 401(k). But what works well at one point in life might not work as well later in life. As workers age, for instance, as they get married, as their financial lives become more complicated, as they invest their money in a variety of different accounts (taxable, tax-free and tax-deferred) as well as different types of investments and products the need for advice grows.

That advice could go a long way toward making sure a worker’s retirement portfolio is appropriately aligned with their goals, time horizon, and risk capacity, and that their asset allocation is right for their facts and circumstances.

Given that plan participants are rolling over their “through” target-date fund over into an IRA when they leave their company plan, the odds of their assets being misallocated, being exposed to more risk than necessary in some cases and not enough in others, becomes even greater, and the need for advice even greater still.

And yet they are not seeking out the advice they might need.

“It’s possible that some participants are in TDFs with a ‘through’ glide path and they should be in a ‘to’ glide path and vice versa,” said Reuter. “And what our findings would suggest is they’re not likely to realize that. They’re not likely to actually find out that, when they get to their retirement age, they may have too much or too little equity relative to what they would want. They’re also not going to know whether the target-date fund that they’re in is the right level risk for them.”

TDFs, said Reuter, are a one-size fits all investment. “And the problem with one-size-fits-all is that if you have heterogeneous people with heterogeneous needs, it probably doesn’t fit any one person particularly well,” he said.

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