Why target-date funds are so popular
When it comes to building their retirement nest egg, investors are increasingly betting on the set-it-and-forget-it approach of target-date funds.
Such funds, which are designed to minimize risk over time by gradually shifting from stocks to bonds as an investor’s retirement date nears, hit a record $880 billion in assets last year, according to Morningstar Research Services.
Target-date funds are the default option for many employee retirement plans, which has helped drive their growth.
The plans appeal to people who want to avoid the worry or responsibility of a hands-on approach to investing, another growing trend. Roughly two of every three dollars that went into target-date plans last year went to those that focused on investing in index funds, which cost less because there’s no portfolio manager picking the investments.
We asked Jeff Holt, associate director at Morningstar Research Services, to weigh in on how target-date funds are faring, and what investors should consider when weighing whether to put money into these types of funds.
Q: What sets these funds apart from one another, or from simply investing directly in another type of hands-off investment, like an index fund or ETF?
A: The distinguishing feature of target-date funds is the glide path, which reflects how they shift different asset classes over time. And that’s based upon the age of the investor. While [all target-date funds] share that common thread of having a glide path and becoming more conservatively positioned, shifting from stocks to bonds over time, the manner in which they do it varies significantly.
On the equity side, there’s U.S. versus international stocks, or large-cap versus small-cap stocks. Even on the bond side, [differences include] the use of high-yield bonds or Treasury inflation-protected securities. All of these are active decisions that a target-date (fund) provider is making in delivering a strategy for investors.
Q: How have target-date funds performed, on average?
A: Benchmarking is complicated with target-date funds because everyone has a different asset mix.
They don’t guarantee that an investor will have enough savings at retirement. What they’re designed to do is provide diversification across U.S. stocks, international stocks and bonds, and to do so in a thoughtful manner.
Because of the diversification, target-date funds will never be the top performer. They should also not be the poorest performer. More or less they should give a balanced mix in terms of performance.
Q: You say it’s too soon to determine if target-date funds will prove effective over the long haul. What’s the concern here?
A: Target-date funds are meant to be a multi-decade investment. They’ve been around since the early 90s, but it was the Pension Protection Act of 2006 that really boosted interest in target-date funds.
So a lot of these strategies don’t have a long track record. It’s still not proven for certain that these strategies will deliver the returns that investors expect.
We’ve seen some promising signs.
More often than not, investors tend to follow performance. They’re buying high and selling low.
Just the construct of having a target-date fund — and just continuing to contribute to a fund that will change over time — has helped investors. — AP