Many of us don’t have the $500,000 in assets most financial advisors require to give hands on retirement planning advice. And with all the complexity involved in making investment decisions, target date funds often seem like an easy answer to the complex task of retirement planning. But the “set it and forget it” allure of target date funds can come with costly limitations.
The infographic below explains why target date funds may not be a good choice for many investors.
Limitation #1 – One Size Does Not Fit All
Investor’s financial situations come in all shapes and sizes. And the central focus of a retirement plan is not simply age and time till retirement. For example, not all 50 year olds with 15 years until retirement have the same level of financial security. Their unique financial circumstances affect their ability to take on risk differently. And thus, they should approach their retirement planning differently, given their personal goals and propensity and capacity for risk.
Limitation #2 – No Control Over Asset Allocation
Asset allocation has the biggest impact on the returns of a long term portfolio. So maintaining an asset allocation that is right for you is a major key to financial success. The portion of your portfolio that’s invested in target date funds is a complete unknown, which make’s keeping your ideal asset allocation for your entire portfolio impossible. And because you can’t control the target date’s asset allocation, you can’t keep the amount of risk you take on in check with your changing life circumstances.
Limitation #3 – Over Exposure to Stocks
The “set it and forget it” selling point of target date funds is intended to be its automatic adjustment of the asset allocation mix to become increasingly conservative as the retirement year approaches. However, as of 2010, target date funds at maturity sat at 43% stocks—not an appropriate level of risk for someone hitting retirement.
Limitation #4 – Conflicts of Interest
Target date funds are actively managed, meaning the funds they hold are hand selected by a fund manager. There’s incentive for the fund manager to stuff the target date funds with high fee funds that are more profitable for them—and can often times be more risky.
Limitation #5 – Added Fees
Because of the active management of target date funds, they charge higher fees than an index fund would. And as mentioned above, target date funds are simply a collection of other funds that also have fees.
Takeaway: By using the right online investment tools, investors can easily create an asset allocation that fits them and with less fees to eat away their returns.