Target-date funds may be limiting your retirement.
Between July 29 and August 2, lawyers representing current and former participants in six separate retirement plans filed suit against their employers and the plan fiduciaries, alleging that BlackRock’s target-date funds in the plans underperformed other popular target date funds. Those lawsuits come four months after mutual fund giant Vanguard was served with a class-action lawsuit alleging Vanguard mismanaged some of its target-date funds to the point that investors were hit with excessive taxes.
In addition to legal action, two recently issued reports cast doubt on investing in target-date mutual funds during retirement, charging that such funds often carry too much risk for retirement investors. The reports, from research firm Morningstar and Boston College’s Carroll School of Management and the TIAA Institute, found that mutual funds do not provide the flexibility and guidance that larger investors often need, and that exposure to stocks in mutual funds with target date also exposes pensioners to a lot of risk. Is it time to cut the bait if you’ve invested in TDFs and are looking for an alternative?
Need help managing your retirement savings? Consider working with a financial advisor.
What are target date funds?
Target-date funds are a class of mutual funds or ETFs that periodically rebalance the fund’s asset class weights to optimize risk and returns over a predetermined time frame, usually to provide cash at the end of the predetermined period. The asset allocation of these funds is designed to gradually shift along a glide path to a more conservative profile to minimize risk as the projected retirement year (i.e. target date) approaches. They are known for their comfort — set-it-and-forget-it investment vehicles.
And TDF popularity is soaring: while only 19% of 401(k) plan participants had target-date funds in 2006, that number rose to 56% by the end of 2018, according to the EBRI database/ ICI 401(k).
Disadvantages of Fund-Target Date
Target-date funds have been plagued by legal woes.
The funds involved in the LifePath Index funds managed by BlackRock do not target fund managers, but charge that entities responsible for running corporate retirement plans stuck with the funds when better-performing investments were available. The complaints were filed against employers and trustees of Capital One Financial Corp. Booz Allen Hamilton Inc. Citigroup Inc.; Stanley Black & Decker Inc.; Cisco Systems Inc.; and Wintrust Financial Corp.
The lawsuit filed by Citigroup employees alleges that “Defendants selected, retained and/or otherwise endorsed poorly performing investments rather than offering more prudent alternative investments that were readily available.”
The class action against Vanguard alleges the firm’s target-date funds suffered when Vanguard changed its policies on investment limits for lower-fee institutional funds, prompting a rush by investors to bail out into more expensive retail funds. The required sale of assets by retail funds hit fund investors with capital gains tax charges that were 40 times higher than previous levels and “left tax-paying investors holding the tax bag”.
Target Fund Challenges Beyond Legal Issues
Target-date funds have other downsides beyond this wave of legal headaches.
If you set your target fund and forget about it, what’s going to happen, one study author said, “is that your circumstances change, and something that might have been a good initial investment may no longer be a good investment. And over long periods of time, that’s problematic.”
The appeal of target-date mutual funds is that they offer investors the convenience of putting their investment activities on autopilot in one vehicle. However, this set-it-and-forget-it approach can be harmful for retirement investors, according to studies from Morningstar, Boston College and the TIAA Institute.
Other critics of target funds have charged that many fund managers continue with an overly aggressive and risky mix of assets at times when funds should be moving to a safer, more conservative and stable mix of investments.
Additionally, target-date funds are typically created using funds from a single fund family within Fidelity or Vanguard, without much diversification. Management fees are often particularly high since you have to pay expense ratios for each fund within the target-date fund. In addition, that target date may not represent additional retirement savings you have outside of the account and is therefore on target with an asset allocation that does not necessarily reflect the reality of your financial situation.
Alternatives to target-date mutual funds
Try a managed account, offered by about half of all retirement plans. This allows you to take into account more than just age.
Try a hybrid model, which allows for more return-seeking assets and personalization, while also incorporating the convenient elements of a TDF.
Try an unwrapped TDF, which allows retirement savers to get under the hood a bit and tailor to specific model portfolios created by the filer with a specific glide path.
Target funds have faced a number of legal problems in recent times. They can also be expensive and offer less in the way of real-world factor adjustment. It may force you to explore other options for your 401(k), and working with a financial advisor can help you navigate the tricky waters of retirement planning.
Retirement Planning Tips
A financial advisor can help you plan for retirement and be able to retire on time. Finding a qualified financial advisor doesn’t have to be difficult. SmartAsset’s free tool matches you with up to three financial advisors serving your area, and you can interview your advisors at no cost to decide who is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
If you have access to a 401(k), make sure you take advantage of every available employer match. this is free money, don’t leave it on the table.
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