What They Don’t Tell You About Target Date Funds
I can’t find the number. However, there is an alarming percentage of people in 401 k plans invested in target date funds. They are also referred to as lifestyle funds or freedom funds. Why so alarming?
Investors think they are getting one thing with target date funds when they are likely getting another.
First, what are target date funds? These are funds that you choose based on your retirement year. Let’s say that you are going to retire in 2030. If that were your retirement year, you would invest your money into that 2030 target date fund. Every year as you get closer to retirement in 2030, the fund is supposed to take less risk. In theory, by the time you get to retirement in 2030, you are taking a minimal level of risk because you are in retirement.
On paper, it sounds like a great strategy. In reality, it is not really the case. Here is an example – Say you were retired in 2020. For the last ten years, you have been invested in the target date 2020 plan. Returns have been good because we have been in a bull market where funds make money. Then 2022 happened, the market has been horrible, and every fund is exposed and only as good as their strategy for risk.
Back to the 2020 fund – If you started retirement two years ago in 2020, and a bear market happened, you would feel pretty safe because you were in a 2020 fund. Being two years into retirement, you would think that the 2020 fund would even be with less risk. Let’s take a look at the performance of target date funds 2020 for 2022 through August of this year.
According to Morningstar, the best return was -8.95%, and the worst return was –16.14%. Does that look like the target date fund of 2020 lived up to its objective? In fact, 95% of all 2020 target date funds had losses in excess of 10%. Did they protect you in your golden years?
Do yourself a favor, and don’t buy into the marketing spin about how these funds are supposed to protect you from risk as you get closer to retirement. These returns on target date funds are pretty consistent with the returns of the last bear marketing 07-09.
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