Target Date Funds Are a Flawed Concept In Your 401 K Plan
Target Date Funds are a popular investment choice in 401 K plans. In fact, more and more 401 K Plans are going in the direction of this concept. There are $1.1 trillion dollars in these funds. It is estimated that by 2023, 70% of investors will use a target date or similar type of fund. Target Date Funds, also called Freedom Funds or Lifestyle Funds, are simple to explain and understand.
First, you pick the year of retirement. Let's say it is 2040. Then you invest your money designed for your retirement target date - the 2040 fund. This fund is designed to reduce risk as you get older and get closer to the year 2040. It "manages" the risk for you.
I could spend a great deal of time writing about the flaws in the concept of these funds. However, for the sake of brevity, I will stick with one big design flaw.
They take way too much risk in the years leading up to retirement and the first few years in retirement. If the stock market took a big hit, the investor could be in trouble. You can ill afford to take a great deal of risk early on in retirement. The time frame of 5 years before and 5 years after retirement is the most crucial time in the lifespan of your investments.
For example, Fidelity Freedom Funds 2020 (same concept as Target Date Funds-retirement in 2020) has 51% invested in stocks both domestically and internationally. That in my opinion is way too much risk. It should be more like 30 to 35%. Then there is the risk measurement of Beta of the fund. A rating of 1 is full market risk. It is rated as a .96. That is way too high of a Beta for that type of time frame.
The worst is that the investor thinks they have everything taken care of because of this concept. That is the problem with Pop Culture Finance. They want everyone to believe that investing is actually easy and something like a target date fund allows you to get to your goals with little interaction of the investor. That is farthest from the truth.
BELOW IS JUST NOTES - ABOVE THIS LINE IS THE BLOG
TDFs have become the preferred investment for 401(k) savers, now holding about $1.1 trillion in assets. By 2023, roughly 70% of investors will use a TDF as their lone 401(k) investment, compared with 52%today, according to Vanguard Group estimates. But their design may be flawed.
Why this stat will grow - reduces liability or so they think it reduces liability
younger participants taking on more risk than they might want - imposing risk -
younger bond allocations a waste of time - glide path -
encourages auto-pilot - commercial
flawed concept around retirement - heaviest during the one time you can't afford to take a hit -
5. misleading assumption - it is easy - save a certain percentage in target date funds and you will retire just like you need to - know why you are saving money - what percentage to save as a component
6. paying a commission - 5.75% 2040 fidelity freedom funds .91 versus .70%
what is the adviser bringing to the table - conflict of interest -