What about those Target Date Funds?

256px-TodayYesterdayTarget Date Funds (TDFs) – either you love them or you hate them. If you lack any tools within your 4o1k, or don’t want to use a qualified adviser, then I guess they’re better than nothing. However, they’re as arbitrary as where the International Date Line (IDL) is … more on arbitrary later in pros and cons … however, the IDL is in some ways less arbitrary than most TDFs.

Robert Merton commented on Target Date Funds in this article “… on the Promise of Reverse Mortgages and the Peril of Target-Date Funds.” Some quotes from the piece as cliff notes here:

  • Target-date funds are an exceptionally bad way to save for retirement …
  • Target-date funds have a date, which Merton said “makes you feel good.” He reminded the audience, though, that the 2010-target funds still exist, which should cause one to question the meaningfulness of a fund’s target date.
  • More to the point, Merton said there are no goals in the prospectus of target-date funds; there is a process, which is the glide path. The date, he said, is the date that the process stops.
  • Your chance of getting to a goal with a customized solution is much greater than with a generic solution.
  • His most strident criticism was that target-date funds lack customization and are based solely on one’s age (or, equivalently, the time to retirement). “Imagine you got your medical advice by age, without respect to gender.” He asked rhetorically, “Would you settle for that for your prescriptions?”

Morningstar discusses the pros and cons of TDFs in a summary. They point out, that even though the names have the same year, they often don’t have similar allocations. It is those managed allocations that are supposed to make them special compared to more specifically arrived allocations, which I might add are more likely than TDFs to have properly incorporated diversification mathematics. Motley Fool also discusses the pros and cons.

Merton’s point about the 2010 fund still existing brings up a point mentioned by Morningstar as well: what happens at the point of retirement? Do you all of a sudden switch to a later dated TDF, and thus suddenly become more aggressive at the point of retirement than you were the day before (called “to retirement)? Or do you pick a fund dated later in retirement to manage allocation all the way through retirement as well (call “through retirement”)?

So the pro of TDFs being their simplicity in selection soon becomes more complex when one considers their own specific situation – and that is the major con for TDFs … they assume everyone is average and define what that average may be … both of which most likely have nothing to do with you and your specific situation, risk capacity, risk tolerance, needs, etc.

Moral of the story: Target Date Funds may create an illusion of an allocation. The question is, is that allocation properly diversified to begin with AND appropriate for your specific situation. They are better than nothing, but that is a poor point of reference when one considers those risks may in truth be more, as compared to taking a bit more effort and responsibility for their retirement funding decisions. I circle back to Merton’s last bullet point above – what kind of prescription would you accept?


Photo: I, Plenz [CC BY-SA 2.5], via Wikimedia Commons

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