Imagine investing in a mutual fund that could automatically make all your investment decisions for you, that could adjust the allocation of your portfolio as you grow older, and eliminate the concerns about which mutual funds to invest in or how to balance your portfolio.
According to the mutual-fund industry, there are such mutual funds. They’re called target-date funds.
Since first introduced in 1994, target-date funds have been marketed as a fund that can help take the guesswork out of saving for retirement. You simply pick a fund with a year in its name (i.e., 2020 or 2030) that is closest to the year when you plan on retiring, and invest your 401(k) and/or IRA savings into that fund. The simplicity of this “set it and forget it” approach to investing has caused the popularity of target-date funds to increase substantially, particularly within participant-directed 401(k) plans. Over the last 10 years, the amount of workplace retirement-plan savings invested in target-date funds has grown from about $158 million to just over $1.1 trillion.
If only investing were that simple.
There is one significant flaw with these funds: They assume that everyone who is the same age or plans on retiring in the same year should have the exact same investment portfolio.
Consider the following example. Two 50-year-old individuals work for the same company and save in their company’s 401(k) plan. They each plan to retire in 15 years with $1 million in savings. They both currently have $250,000 in their 401(k) plan’s 2035 target-date fund. One employee plans on saving $10,000 each year into the 2035 target-date fund, and the other plans on saving $2,000 each year into the fund. Based on the significant differences in their annual contributions, it is obvious that the 2035 target-date fund is not appropriate for both of these individuals.
The simple truth is that target-date funds are, essentially, a cookie-cutter, one-size-fits-all approach to investing. And when it comes to investing, there is no such thing as a one-size-fits-all portfolio. There is no single asset allocation that will work for everyone. Not everyone has the same goal, time horizon, risk tolerance or circumstance.
An investment strategy must take into account how you will achieve your goals, given your financial situation. It should be tailored to meet your goals because your situation is different than anyone else’s. Unfortunately, target-date funds are not based on any of these things. The only two factors these funds use to make investment decisions are a person’s age and the year in which they plan to retire. That’s it … nothing more.
Martin Krikorian is President of Capital Wealth Management, a registered investment adviser providing “Fee-Only” investment management services located at 9 Billerica Road, Chelmsford MA. He is the author of the investment books, “10 Chapters to Having a Successful Investment Portfolio” and the “7 Steps to Becoming a Better Investor.” Martin can be reached at (978) 244-9254, Capital Wealth Managements website; www.capitalwealthmngt.com, or via email at, firstname.lastname@example.org