Wednesday, July 30th 2014

Target Date Retirement Funds versus Target Asset Allocation Funds

by Mr Credit Card

One of the more recent “innovations” (if you call even call it that) in the mutual fund industry is the “target date retirement funds”. How this works is as follows : You pick the year which you want to retire and then select the funds simply based on that. How simple. There are some pros and good points about these type of funds.

1. Set and forget – Investing in these funds is so simple and you can set and forget about it in your retirement accounts or taxable accounts.

2. Asset Allocation determined for you – How wonderful. You do not have to worry about picking large cap growth or value funds, international funds, reit fund etc. Asset allocation is done for you.

3. Rebalancing – When you manage your own portfolio, you have to periodically rebalance them when different asset classes get out of line. With a retirement target date fund, this is automatically done for you.

4. Asset allocation changes as you approach retirement date – Another great feature of such funds is that asset allocation gets more conservative as you approach you retirement date.

Despite these great features, there are a couple of things you have to be aware of.

1. Present asset allocation model may be unsuitable for your risk tolerance – If you are a very conservative investor and have 25 years to retire, chances are that you target date retirement portfolio will consist of all equity. If you have low risk tolerance, perhaps and 50% stock, 50% bond allocation is more appropriate. This in my opinion, is the biggest issue I have with target date retirement funds – which is the inconsistency of their model versus your risk tolerance.

2. This only works perfectly if retirement is your only goal – But if you have other financial goals like saving to start a new business, then such a portfolio is not suitable.

Alternative – Asset Allocation Funds – An alternative to retirement target date funds is the asset allocation funds. If you know your risk tolerance, you can then choose an asset allocation with a volatility that you can live with. There are many such funds around and I think this is a much better alternative.

Asset allocations funds essentially offer the same set and forget, automatic rebalancing features and but gives you the flexibility to choose an appropriate portfolio based on your level of risk tolerance for market fluctuations.

Asset allocation funds also have portfolios with tax-exempt bonds if you are in a high tax bracket. I have not seen such features in retirement date funds yet.

Has anyone reading this have target date retirement funds or asset allocation funds? Please share your views.

One Response to “Target Date Retirement Funds versus Target Asset Allocation Funds”

  1. Ray Says:

    Sure you can say negative things about the Target Date “Retirement” funds, but they are just that…. “Retirement” funds which have a target date. So, I’d have to disagree with #2, since these are specifically for retirement, thus the date they “mature”.

    I’d also disagree with #1, because the whole point of a target date retirement fund is to “set it and forget it”. Someone who chooses a retirement date of say 2030 isn’t going to care what his retirement fund does tomorrow, 10 years for now etc. If they do, then they would of never of picked a target retirement date to begin with.

    As far as #3 goes, I’d day it’s a toss-up.

    I personally don’t agree with using these funds, just because I like to be more hands on and these target funds can not give you the extreme risk you want. Now, if you allocate 20% to a target date fund, then you have 80% which you can invest in emerging markets, tech, blue chips etc.

    The bottom line is a target date retirement fund is simply a fund for people who don’t want to manage their money, but want something they can choose and lock in, which will mature 5, 10, 20, 30 or more years down the road.

    For people who don’t want to manage their money, they can pick one of these funds, and it should grow at a steady pace, probably similar to the S&P 500 over the long term.

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