Should You Leave Your Retirement Target-Date Fund?

Do your eyes glaze over when you hear target-date fund? Sure, they’re common. At one time or another, probably every investor has had one and you probably do now. But should you? While they can be a good all-purpose solution, and a no-brainer default in many employers’ retirement plans, they’re not appropriate for everyone.

When is a target-date retirement fund not right for you?

More Than One Target Fund
It’s a one-stop shop, but some people attempt to hedge their bets by selecting target funds with two or three end dates. When asked, I usually hear two reasons: either “I wanted to diversify” or “I wasn’t sure when I’d retire.”

You don’t need more than one date. If all your target funds are from the same company, likely in an employer plan, they’re probably going to be in the exact same investment, but just different percentages. So, your year 2040 plan may have 50% in U.S. stocks. Your 2045 fund may have 54%, but it’s invested in the same underlying fund. The fund per-centages are based on the fund manager’s assessment of how much risk you should be taking if you want to retire on a certain date.

Similarly, the retirement date is just approximate. Let’s say you plan on retiring in 2030, when you’ll be 65, but if things don’t go so well savings-wise, or you decide you love your job, maybe you won’t retire until you’re 70, in 2035.

Rather than divide your money between two funds, think about your risk tolerance.

Will your Social Security be high enough to cover your basic expenses? Will you have a pension? Then you can probably choose to take a bit of risk, so you’d choose the later date, 2035, which will have a slightly more aggressive balance. On the other hand, if the fund represents every penny of your investments, and you’re in danger of a layoff before 65, you may have less risk tolerance and could choose the 2030 fund. Funds are presented in five-year increments, but the difference in asset balance is very small, until you get to the 10-year increment.

Risk Tolerance

Let’s say you’re 58 and expect to inherit $5 million from your 101-year-old mother. You can probably tolerate more risk in your own retirement account because it’s extremely likely you’ll have more money by the time you retire. Also, let’s say the retirement account is relatively small. While it’s definitely worthwhile to keep investing in a tax-sheltered account, you’ll have some backstop from the inheritance. Thus, you might choose a target date designed for someone much younger. You can tolerate the risk because it won’t be your only money, you might not need to make large immediate with­drawals at retirement and you can benefit by the increased return that an equity-heavy portfolio shows over long periods. Nevertheless, you want the easy diversification that a target-date fund offers.

Conversely, let’s say that looking at a recent big loss in your target fund has given you a panic attack. Just because a money manager thinks he knows what risk you should take doesn’t mean he’s right about you. Some people absolutely want a safe investment with very little movement and aren’t as worried about maximizing growth.

So, pick a target date that assumes you’re older than what you are. If you are going to retire in 2030, but want a much less volatile investment, you might choose a 2020 target date. You can pick any retirement date you want, there’s no test!

More Than One Investment

A retirement account may represent all the savings you have for investment. While that certainly means the money is important to you, you will get diversification through the different investments of the target fund.

Sometimes people decide to add “a little something.” They’ll hold a target fund, but decide the S&P 500 is doing pretty well, so they’ll put half their contribution into an S&P 500 fund. Or they’ll get nervous and decide a bond fund, or a gold fund or a stable value fund gets some of their money. They’ve just destroyed the value of the target-date balance. Now, instead of having 60% in stock funds, they have 80% — a much riskier stra­tegy. Or they’ve diminished their possible return by going too conservative. As the saying goes, either go big or go home. Either the target-date fund is your complete choice, with an acceptable asset balance, or you need to choose your own individual asset classes in funds, or a different fund whose balance mirrors what you really want.

The exception I recommend to this is if you have one particular account to which you don’t want to pay a lot of individual attention. Let’s say you’ve changed jobs a few times and have rolled most of your old 401(k)s into an individual retirement account or Roth IRA. You’re investing in mutual funds, individual stocks, etc. But in your new job you have a 401(k) with about $20,000 invested. You might choose a target-date fund for just that account, or a small Roth or IRA, and let it ride while you focus on your self-managed or adviser-managed accounts.

High Fees and Rollovers

If the target fund is in your employer’s plan, you’re probably stuck with what company they’ve selected. You pick your date, after taking time to look at the asset mix and whether it matches your comfort level. But when you leave the job, or are selecting an investment for an individual account, you have an opportunity to change your selection. All funds are not the same, and can reflect a different judgment on the part of the manager. For example, T. Rowe Price Retirement 2030 (ticker: TRRCX) has 48.55% of the port­folio invested in U.S. equities. Fidelity Freedom 2030 (FFFEX) has 30.84% in U.S. equities. Which one of them matches your own preferred mix?

Similarly, you should check what the management fees are. A fund with an active management style will generally have higher fees than where, essentially, an algorithm is choosing a prefab mix of low cost index funds. The fee for FFFEX is 0.68%; TRRCX is at 0.65%; and Vanguard Target Retirement 2030 (VTHRX) is 0.14%. Over time, low fees have been shown to contribute to better returns.

Once you have the power to choose among different companies in an individual account, you should compare long-term results, portfolio mix and management fees to select the best fund for you. If you leave an employer and rollover your account, choose the best available fund.

Stopping the Clock

If you’re young without much money in an account, a target-date fund is an easy choice for good diversification and regular contributions. Once you get closer to retirement, you may want to stick with a specific mix. Maybe you’ve saved more than you thought possible and have a pension or have purchased a fixed annuity. You won’t need a target fund that moves you into 70% bonds after retirement — you can afford to take more risk for more return. At some point near or after retirement, a target balance may just be too conservative and a balanced fund with a fixed allocation to equities and fixed income may be more satisfactory. Remember, the performance listed for any target fund can be expected to return less over time as it becomes more conservative. The fund that once returned 7% when mostly allocated to stocks might only return 4% when it moves to a dominant bond allocation.

There’s nothing to prevent you from investing in a target fund when it’s appropriate, then moving out of it when something else better meets your needs. It’s easy to move out of the fund, withdraw money or change directions — an advantage in an all-purpose fund.