Target-Date Funds: Missing their Mark?

Target-date funds were supposed to be the solution to the nation's looming retirement crisis, not money-destroyers.

With Americans not saving enough for retirement, and too many making poor investment choices, the funds were established to be no-brainer 401(k) choices. Congress gave companies the go-ahead in 2007 to automatically put a little money from their employees' paychecks into the funds in 401(k) plans, and let the funds get the individuals ready for the day they would retire.

Investors added money of their own, embracing the simple concept of giving a professional their retirement date and then having the pros choose stocks and bonds. But then came the stock market crash of 2008 - many of these funds performed badly, even though they were pitched as low-risk. People about to retire saw about 41 percent of their savings vanish in 2008, and another 23% in 2010. It was a shock to people who thought target-date funds made their money safe as they approached retirement.

That’s why Congress and several federal agencies have been investigating them recently. The most misleading selling point of target-date funds is that they securely produce a set amount of money about the time you retire. Yet they're not principal-protected and they’re also not very flexible.

What if you need to work longer and desire more growth in your portfolio? What if you have to leave the workforce due to disability and need to eschew all market risk? A comprehensive financial plan addresses these needs; a target-date fund doesn't.

There are three distinct pieces to a comprehensive plan. The first is an realistic assessment of the amount of risk you can tolerate. I'm not talking about taking a gut-check of how much you can afford to lose before you suffer from insomnia or dyspepsia. Before you craft a portfolio, your occupational risk measure is essential. Are you working in real estate? Consider ramping up your broad-based holdings in bonds. In a secure government job? Possibly
stocks can take center stage.

An essential second link in building your portfolio is to customize a risk-savvy portfolio. Beware the boilerplates offered by financial advisors and
“consultants,” though. Brokers will give you a pre-set stock/bond allocation based on your age with little consideration paid to cost, labor-market risk, or family situations. That's always been a faulty sales pitch, which is usually loaded up with expensive, poor-performing “house” products designed to earn commissions and generate fees. Instead, build a portfolio based on the risks that scare you the most and the ones you can’t predict.

The last piece of your plan is flexibility. Are you in the late stages of a college-education funding program? You won’t need a broker or advisor to protect your money. Federally insured certificates of deposit are wise.

What if you want to work longer or start another career? That’s a likely scenario for those who have shattered retirement portfolios or bruised careers. I know several people in their seventh decade who are onto their third occupation.

Whatever you do, don't assume that any robotic "lifestyle'' or target-date mutual fund or 401(k) package will suit your long-term needs or adequately shelter you from the most pernicious risks.

If you decide that you just don't want to be bothered -- or can't afford a money manager or financial planner because you have less than $100,000 to invest -- then choose a lower-risk target-date fund. Also keep an eye on costs. Broker-sold funds are the most expensive. Low-cost, conservative funds are available from the Vanguard Group, T. Rowe Price (TROW) and American Funds.

Along with risk, fund transparency is non-negotiable. If you buy a portfolio plan or do it yourself, know what's inside of the box.

You may not be fully aware of what’s inside a lifecycle fund package. The risks you're taking are not fully disclosed and the whole package may cost you more in annual fund expenses than the sum of its parts.

Just keep in mind that if you choose a lifecycle fund, there are never guarantees of principal. The package looks great until the market tanks. With a flexible and comprehensive plan, there's no need to suffer an impaired lifestyle in the future. If you plan right, you shouldn't be mortified when you open your statements.