Target date funds can be a great hands-off option for many investors who simply don’t have the time to manage their retirement portfolios. All you have to do is select a year around when you expect to retire, and the fund manager will worry about asset allocation. As you get older, the portfolio will shift more assets from stocks to bonds, theoretically leading to a less volatile portfolio.
Target date funds can do a great job of managing a portfolio and ensuring the risk profile is appropriate leading up to retirement. But once you’re in retirement, they can fall short by allocating far too much of the portfolio to bonds.
A look at a target date fund glide path
The changes in asset allocation over time in a portfolio are called a glide path. A target date fund follows a specified glide path, which is usually laid out in its prospectus or the fund company’s website.
For example, Vanguard’s target date funds invest 90% in equities and 10% in bonds until 25 years from the target retirement date. Then it slowly increases the allocation of bonds every year until it reaches 50% bonds and 50% equities by retirement. It continues to increase exposure to bonds over the next seven years until it reaches 70% bonds and 30% stocks, which is where it stays throughout the rest of the fund’s life.
While there’s no standard glide path for target date funds, most follow a very similar trajectory. The automatic rebalancing for target date funds can benefit many investors who don’t have the time, energy, or interest to engage in any amount of portfolio management. However, there are some important drawbacks to consider.
Target date funds don’t know about your other assets
In retirement planning, it’s important to consider all of your assets and how you might use them to fund your spending. One of the biggest assets you’ll have in retirement are your Social Security benefits.
The average monthly Social Security check is $1,669.44. The average person is expected to collect their benefits for 19 and a half years based on life expectancy at 65 and the average age people start collecting benefits. That makes the present value of the average Social Security benefit equal to about $295,000 at a 3% discount rate. (Remember, Social Security is adjusted for inflation every year, so that discount rate may be generous.) If you can expect to live longer or earn a higher than average salary during your working career, your Social Security benefits will be worth even more.
Social Security ought to be …….