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Target Date Funds: How These Long-Term Investments Can Benefit Your Portfolio

February 1, 2011 5 Min Read Interviews
Mark G. Metzler, CPA, CGMA, CEPA
Mark G. Metzler, CPA, CGMA, CEPA Director, Audit & Accounting

This article originally appeared in the February 2011 issue of Smart Business Philadelphia magazine.

As we enter the second month of 2011, it’s time to think of some of the resolutions made just a short time ago. For some, it was to lose weight, eat better and exercise more frequently; for others, it was to save more and invest wisely.

As more and more people are increasingly concerned about the viability of our nation’s Social Security system, the focus has continued to shift toward providing for our own retirement, says Mark G. Metzler, director, Audit & Accounting, at Kreischer Miller.

"One mechanism that owners of businesses and their employees often have is their company’s 401(k) retirement plan," says Metzler. "Because many people are not professional investment managers, an option provided in many plans is ‘target date retirement funds,’ sometimes referred to as ‘target date funds’ or ‘lifecycle funds.’"

Smart Business spoke with Metzler about target date funds and how they can work for you.

What are target date funds?

Target date funds, which have grown in popularity in recent years, are long-term investments, typically mutual funds that hold a mix of stocks, bonds and other investments designed to reduce overall risk. The funds are generally structured as investments for individuals with particular retirement dates in mind. The name of the fund often refers to its target retirement date (e.g., Retirement Fund 2025). As a fund gets closer to its named target date, the investment mix shifts to become more conservative.

This is appropriate because an individual nearing retirement may wish to have his or her investments become more liquid to provide for living expenses, as well as to minimize losses in a volatile market. Ideally, the target date retirement fund concept is a simple way to provide for professional portfolio management. The investment firms sponsoring the funds make the investment allocation decisions for participants based upon the target date.

Are all types of target date funds basically alike?

No. Funds that share the same target date may have significantly different investment strategies and risk profiles. The Department of Labor’s Employee Benefits Security Administration (EBSA) and the Securities and Exchange Commission (SEC) published an investor bulletin stressing that ‘participants should not rely on the fund’s target date as the sole criterion for selecting the investment because funds with the exact same target date may have entirely different risk strategies, risks, returns and fees.’

One of the most significant differences among target date funds is the construction of the ‘glide path.’ The glide path represents the asset allocation philosophy among equities, bonds, cash and other investments at various times throughout the investment life of a participant. Typically, all target date funds have a higher exposure to equities when the participant is furthest from retirement (at the beginning of the glide path) and steadily decrease the exposure to equities as the individual approaches retirement age.

However, different investment managers may have significantly different strategies for a similar target date fund.

The EBSA and SEC provided an example in their bulletin of the extreme differences between target funds with identical target dates. In the example, at its target date, Fund A had an asset allocation of 60 percent stocks and 40 percent bonds, while Fund B maintained an allocation of 25 percent stocks, 65 percent bonds and 10 percent cash investments.

Fund A does not reach its most conservative mix of 30 percent stocks and 70 percent bonds until 25 years after its target date.

How can funds with the same target date have such significantly different investment philosophies?

In the simplest terms, it depends upon whether the fund manager is investing ‘to retirement’ or ‘through retirement.’ When the fund manager invests ‘to retirement,’ it is anticipated that a significant portion of the portfolio will be liquidated at the target date to provide for living expenses, so therefore it would comprise a much smaller percentage of equities. Conversely, when a fund manager invests ‘through retirement,’ it is anticipated that the individual will continue to have a much higher exposure to equities and will continue to invest in the market throughout his or her retirement years.

In the 2008/2009 market downturn, participants close to retirement whose target date funds followed the ‘through retirement’ date philosophy were shocked at the large losses their funds suffered as they mistakenly believed they had been shielded from substantial loss by investing in a target date fund.

What should someone consider when evaluating a target date fund?

First, remember that all investments have some level of risk, and even the same type of investment may have more or less risk than other seemingly identical ones. Participants should read the fund’s prospectus to focus on:

  • When does the most conservative mix of investments occur?
  • What is the fund’s risk level?
  • How has the fund performed in the past, and what is the fund’s Morningstar ranking?
  • How does the asset allocation change over the life of the fund?
  • What fees apply?

Target date funds provide simplification to the average investor. While there is no magic pill that provides for a guaranteed return or that eliminates the risk of loss, target date funds do provide a level of portfolio management and complexity that is typically out of reach for most investors.●



Contact the Author

Mark G. Metzler, CPA, CGMA, CEPA

Mark G. Metzler, CPA, CGMA, CEPA

Director, Audit & Accounting

Employee Benefit Plans Specialist, Owner Operated Private Companies Specialist, Private Equity-Backed Companies Specialist

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