Target-date funds may be cramping your retirement.
Between July 29 and Aug. 2, lawyers representing current and past participants in six separate retirement plans filed suit against their employers and plan fiduciaries, charging that the BlackRock target-date funds in the plans performed worse than other popular target-date funds. Those lawsuits come four months after mutual fund giant Vanguard was served with a class-action suit charging that Vanguard mismanaged some of its target-date funds to the point where the investors where slammed with excessive tax bills.
In addition to the legal actions, two recently issued reports cast doubt on investing in target-date funds in retirement, charging that such funds often carry too much risk for retired investors. The reports, from research firm Morningstar and Boston College’s Carroll School of Management and the TIAA Institute, found that the fund’s don’t provide the flexibility and guidance older investors often need, and that the equity exposure in target-date funds exposes retirees to too much risk. Is it time to cut bait if you’re invested in TDFs and look for an alternative?
Want help managing your retirement savings? Consider working with a financial advisor.
What Are Target-Date Funds?
Target-date funds are a class of mutual funds or ETFs that periodically rebalance the fund’s asset class weights to optimize risk and returns for a predetermined time frame, typically to provide cash at the end of the pre-set period. The asset allocation of these funds is designed to gradually shift along a glidepath to a more conservative profile so as to minimize risk when the prescribed retirement year (i.e. the target date) approaches. They’re known for their convenience — set-it and forget-it investment vehicles.
And TDF popularity is soaring: whereas only 19% of 401(k) plan participants had target date funds in 2006, percentage rose to56% by the end of 2018, according to the EBRI/ICI 401(k) database.
Target-Date Fund Disadvantages
Target-date funds have been saddled by legal woes.
The suits involving the LifePath Index Funds operated by BlackRock don’t target the fund managers, but charge that entities responsible for running company retirement plans stuck with the funds when better-performing investments were available. The complaints were filed against employers and fiduciaries for Capital One Financial Corp.; Booz Allen Hamilton Inc.; Citigroup Inc.; Stanley Black & Decker Inc.; Cisco Systems Inc.; and Wintrust Financial Corp.
The suit filed by Citigroup employees claims that, “defendants selected, retained, and/or otherwise ratified poorly-performing investments instead of offering more prudent alternative investments that were readily available.”
The class-action effort against Vanguard alleges that the company’s target-date funds suffered when Vanguard changed its policies regarding investment thresholds for its lower-fee institution funds, resulting in a rush of investors bailing on more expensive retail funds. The necessary sale of assets from the retail funds slapped fund investors with capital gains taxes that the suit charges were 40 times previous levels and “left taxable investors holding the tax bag.”
Target-Date Fund Challenges Beyond Legal Troubles
Target-date funds have other detriments beyond this spate of legal headaches.
If you set your target-date fund and forget it, what’s going to happen, said one study author, “Is that your circumstances change and something that may have been a good initial investment may no longer be a good investment. And over long periods of time, that’s problematic.”
The appeal of target-date funds is that they offer investors the convenience of putting their investing activities on autopilot in one vehicle. But this “set-it and forget it” approach can be harmful to retired investors, according to the the studies from Morningstar, Boston College and the TIAA Institute.
Other critics of target-date funds have charged that many fund managers continue with an overly aggressive and risky asset mix at times when the funds should be shifted to a safer, more conservative and stable mix of investments.
In addition, target-date funds typically are built using funds from just one fund family within Fidelity or Vanguard, without lots of diversification. The management fees are often particularly high given that you have to pay expense ratios for every fund within the target-date fund. What’s more, the target-date in question may not account for addition retirement savings you have outside of the account and thus is on target with an asset-allocation that does not necessarily reflect the reality of your financial situation.
Target-Date Fund Alternatives
Try a managed account, offered in about half of all retirement plans. This allows you to take into account more than just age.
Try a hybrid model, that allows for more return-seeking assets and customization while also incorporating the convenient elements of a TDF.
Try an unwrapped TDF, which allows retirement savers to get under the hood a bit and customize according to specific model portfolios created by the record keeper with a particular glide path.
Target-date funds have faced a litany of legal troubles of late. They also can be costly and offer less in the way of customization based on real-world factors. It may behoove you to explore other options for your 401(k) and working with a financial advisor can help you navigate the challenging waters of retirement planning.
Retirement Planning Tips
A financial advisor can help you plan for retirement and be able to retire on time. Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
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