Many retirement plans and individual retirement accounts offer the option to select target date retirement mutual funds. The concept sounds simple: estimate your intended retirement year, select the corresponding target date fund, and presto—you have an all-in-one allocation designed to shift your asset mix and reduce risk as you approach retirement.
Sounds simple, right? If only it were that easy…
Target date funds generally do a good job approximating an appropriate allocation based on a single input: your expected retirement year. Early in your career, the allocation leans toward riskier assets such as stocks, offering higher return potential alongside greater price volatility. As you age and near your target retirement date, these funds gradually shift toward more stable fixed income investments, sparing you the need to actively rebalance.
For many investors, the automatic nature of target date funds provides valuable simplicity and helps improve long-term outcomes. However, there are important considerations to keep in mind before adopting a “set-it-and-forget-it” approach.
Single Input Limitations
Target date funds use your planned retirement year as their sole input when determining asset allocation and risk profiles. While this approach suits many investors, it can fail to account for outside factors that impact your overall financial situation. For example:
- Do you have significant assets outside your retirement accounts, such as real estate or taxable investments, that can influence your risk tolerance or cash flow needs?
- Has a major life event, such as an inheritance or business sale, significantly changed your financial picture?
Taking a holistic view of your entire financial situation allows for a more customized retirement allocation that may better align with your personal goals and risk tolerance beyond the simplicity of target date funds.
Assessing the Correct Risk Level
During the recent 2022 bear market, both stock and bond markets suffered double-digit declines, which adversely impacted near-retirees invested in target date funds with allocations that remained partially in equities and bonds. For instance, funds with a 2025 target date experienced losses of approximately 20% as rising interest rates and geopolitical uncertainty shook markets.
Could these losses have been avoided? Market timing is notoriously difficult and inconsistent. However, a thorough risk assessment incorporating scenario analysis and customized portfolio stress testing might have provided greater insight into potential drawdowns and better positioned investors for volatility.
Personalized Financial Planning
While target date funds simplify retirement investing for many, they should not be seen as a one-size-fits-all solution. Your asset allocation should align with your individual ability and willingness to take risk, considering all components of your financial life, including savings, investments, and other assets.
If you have questions about your retirement allocation or overall financial strategy, please reach out to Vindicta Investment Advisors to discuss your unique situation confidentially.
The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own situation before making any investment decision.