Target-date funds are a staple of employer-sponsored
retirement funds, due in part to their ease of use. The funds adjust
allocations over decades, starting with big equity exposures, then glide
gradually into more fixed income.
But some investors don’t stick with them, particularly after
they retire. Thinking they can do a better job of managing their money than a
target-date funds’ manager, some investors shift the money into individual
retirement accounts where they invest in other types of funds.
Is that the right move? Here are six things to consider
before quitting a target-date fund:
Upsides to leaving
1. Target-date funds are short on customization
While one of the marketing points of target-date funds is
that the funds are supposedly designed for the expected retirement year, the
actual target dates typically are five years apart. That means investors
usually end up choosing a fund with the date closest to the year in which they
plan to leave full-time work. But retirement dates can change. The dates chosen
can be off by years—as can someone’s preferred risk level.
In target-date funds from Vanguard Group—the largest manager
of employer-retirement plan dollars—about half of a portfolio is still in
stocks when an investor turns 65. Such allocations are intended to spur growth
and reduce the risk that someone outlives savings. But it can mean a bumpy
ride. In last year’s volatility, some Vanguard target-date funds briefly shed
nearly 20% of their share prices.
Employer plans typically feature target-date funds from just
one manager, so an IRA would provide many more options—including funds from
other firms with lower equity exposure. JP Morgan Asset Management offers some
funds that hold less than a third of their assets in stocks by an investor’s
retirement date.
2. A different approach might better meet an investor’s
needs
While some target-date funds yield around 2%, from
dividends, bonds and other fixed-income investments, it’s common for yields to
be lower—particularly for a fund that has a larger equity allocation.
Target-date funds are primarily designed for asset growth. Most seek to achieve
that through equities, and often dividends aren’t a primary concern.
“As you’re entering retirement or in retirement, it’s
certainly worth taking a look at whether the equity and income allocations
within a target-date fund are where you want them to be for your needs,” says
Kathy Carey, head of asset-manager research at Robert W. Baird & Co.
If an investor is concerned about making next month’s rent,
it could make sense to also own a fund that throws off more income—whether as
part of an employer plan or in an IRA. But it is important to realize that
mixing target-date funds with other types of funds can undermine the key
objective of getting some continuing growth of assets through retirement,
experts say.
3. Savvy investors can lower their costs
Fund fees can seem like a moot issue to investors who have
the bulk of their income-earning years behind them. While the huge growth of
ETFs clearly has put downward pressure on target-date-fund fees, participants
in defined-contribution plans—where most people own a target-date fund—tend to
pay less attention to such things. Many like the “set it and forget it”
strategy that those funds provide.
But investment costs are still an important concern to older
investors, says Matt Brancato, head of Vanguard Institutional Investor
Services. The amount of assets in a retirement portfolio likely has peaked at
the time of retirement, and, since fund fees are based on a percentage of
assets, investors can be paying more than they realize—and more than they have
to.
According to an analysis last year by University of Arizona
Prof. David Brown and University of Colorado Prof. Shaun Davis, Americans could
be paying in excess of $2 billion a year more than they would if they managed
their own savings with a portfolio of low-fee ETFs. One reason for inflated
fees, the professors say: Many fund managers stock their target-date-fund
portfolios with their own actively managed products, which tend to have much
higher fees.
Funds, including target-date funds, that rely on low-cost
indexes, by contrast, feature lower fees than target-date funds found in many
employer-sponsored plans.
Upsides to staying
1. Cheaper alternatives can be hard to find
Although an IRA would give a retiree much more flexibility
in getting low-fee ETFs, there is also a risk of inadvertently paying more,
depending on the choice of IRA or the funds within it, cautions David
Blanchett, head of retirement research for Morningstar Investment Management.
He says that employer plans, which have the leverage of many
participants, typically negotiate lower, institutional-level fund fees for
funds they offer. Fees could be higher if an investor, outside of a plan,
chooses funds that are available only in costlier classes of shares.
While many self-directed IRAs charge nothing to own an
account, others can carry significantly higher fees because they include a
professional-advice feature. Anyone considering rolling retirement funds into
an IRA needs to carefully examine the IRA’s features and understand what they
are getting into, Mr. Blanchett says.
2. You’re already getting advice, likely for less than
many advisers charge
Target-date funds themselves—even those based on index
funds—contain embedded professional advice, because they are designed and
overseen by professional managers, Mr. Blanchett says. Investors often also get
no-cost phone consultations with a professional to learn about the investments
in a plan.
Detailed, personal advice often comes at a cost, although it
can be less than many investors would pay if they hired an adviser themselves.
A spokesperson at Fidelity says its personalized planning and advice services
might cost around $50 per $10,000 of an account’s value—depending on the
account’s overall value—although those services are provided free in some
employer plans.
Advice could be valuable for a less-savvy investor, enabling
that person to consider how a target-date fund fits into his or her entire
financial picture, says Ms. Carey of Baird.
3. Target-date funds operate with time and
diversification in mind
Target-date funds provide a so-called glide path, which
means the equity allocation is automatically reduced as the planned retirement
date approaches. But some, such as the TIAA-CREF Lifecycle Funds, also give
managers the flexibility to tweak their allocations as market conditions
change.
In spring 2020, the TIAA-CREF target-date funds modestly
increased their positions in the high-yield bond market after that sector was
slammed along with markets broadly, says John Cunniff, a portfolio manager for
the funds.
Target-date funds commonly spread money around in thousands
of individual securities, ranging from U.S. stocks to local-currency
emerging-markets bonds and inflation-linked securities—markets that individuals
might find challenging to navigate on their own.
“People often focus just on the equity exposure, but that’s
an oversimplification of what’s in the strategy,” says Brett Sumsion, a
co-portfolio manager for Fidelity target-date funds. “We introduce a lot of
diversifying asset classes in order to create a more resilient allocation at
retirement and beyond.”
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