Target Date Funds

A fairly new financial product hit the shelves several years ago and rapidly gained popularity. The product was called "target date funds". On the surface they seemed like a good idea. They were put out by fund companies and would consist of a mix of equity funds and bond funds. The fund would lighten stock positions and add bond positions as the target date, presumably one's retirement date, approached. Thus when one retired, the fund would be nice and stable because it is so bond heavy. The investor doesn't have to worry about changing the mix. All he has to do is keep dollar-cost-averaging by pumping money into the fund through fair times and foul.

Sounds good. But not so fast. There are several deficiencies with this approach.

First, the mix should be adjusted based on how close you are to having sufficient wealth to accomplish your goals and support your desired lifestyle. If you have enough, you should have less stock exposure, regardless of how close you are to retirement. If you don't have enough, you may have to remain a bit more stock heavy even into retirement. Realize that you could live twenty or thirty years after you retire. "Do I have enough?" is a tough question to answer, and most people need professional help arriving at the answer.

Second, you lose the opportunity during stock corrections to make money by selling some bonds and buying some stocks. Your target date funds just sit there and adjust based on your retirement date. Golden opportunities to add funds at low prices are forfeited. If you have a diversified portfolio of mutual funds, you can sell some of your funds that are up, or at least hold value, to buy some of what is down in price. Buy low and sell high. If you have but one fund (a target date fund) there is nothing you can do except endure the volatility.

Third, if we are talking about target date funds purchased with after-tax money, your ability to take tax-advantaged moves is limited. You can sell your fund in the pit of a bear market, but then you must remain un-invested for a while to avoid wash sale tax disallowances. Better to have a diversified portfolio of mutual funds with a mix of equity and bond funds. You can sell equity funds and buy right back into good quality like-type funds, thus capturing tax losses to offset future income, while remaining fully invested.

Fourth, target date funds are run by fund companies. Thus they will use their own funds. Fund companies are rarely good at everything, so there will be some weak funds in your target date fund. This is simply because the fund family doesn't have a good fund for that category. Some of the larger fund families may use some of their weaker funds that are struggling and end up needing additional investor money.

Investing is pretty hairy. It seems that target date funds are too simplistic to rely on for one's financial security. Better to have a fully diversified portfolio of mutual funds that are being actively managed. This portfolio can be of generally higher quality funds, can be tailored more accurately to meet your financial needs, and be managed to great advantage during down markets.