Retirement planning may be getting easier, but it certainly is not getting cheaper. To add to the supply of retirement instruments, a new breed of mutual fund has emerged: the target fund.
These funds seek to minimize the effort required to manage a hefty portfolio by focusing on asset allocation, rather than investment return. These new super-funds are typically outsourced middlemen, which translate to merely a way to charge more fees. The amount invested in target funds is growing at an unbelievable pace, meaning more and more people are putting their nest egg into these retirement vehicles.
Target funds are now the staple of investing around the world. While these funds make the one-stop-shop a reality, they come with high costs, lowered returns, and an overwhelming emphasis on investment allocation by letting other funds do the investing, while target fund managers supervise.
Target funds are sold by the target date that an investor wishes to retire. The funds are normally numbered every five years and place emphasis on a changing portfolio as you near retirement age. Almost every mutual fund family has a target fund offer, often a collection of the other funds within the family.
Where is the benefit?
The only tangible benefit of target funds is in the time saved. The average investor, who may not feel comfortable adjusting retirement money annually, leaves the task to a hired manager a manager who tacks on a fee for a slight change in investments.
Frankly, other than reducing the amount of studying needed to find the best way to plan your retirement, you put your entire retired future in the hands of one manager who then divides your investment dollars as they see fit.
The concept is simple, yet misleading
The concept of invest and forget is simple, and its catching on with small investors. A common misconception is that picking a target date will automatically make it possible for retirement on that date. Younger investors are duped into the idea that investing in a 2015 target fund will make it possible to retire within 7 years, when in reality, a 2015 fund would be geared toward lower returns rather than high returns.
Target funds are fundamentally ineffective
While individuals may seek “easy” retirement vehicles, target funds are not optimal when it comes to growing your elderly nest egg. There are three fundamental reasons why target funds do not give your retirement funds justice:
- Target funds cost far too much as a retirement instrument, and they do not provide a higher return than could be expected from other funds. The benefit of investing in a fund of funds is rarely outweighed by the stress put on retirement accounts through various user fees. These funds are often repackaged mutual funds that have not yet reached their investment quota. You must ask yourself, is the time saved worth the high costs?
- Target funds are often over diversified/under diversified. It is difficult for a target fund manager to reach true diversification by investing in other funds with no disclosed holdings. Often a manager might place funds in several different other growth style funds, which all happen to own the same holdings. Index funds do a much better job of overall diversification without added asset fees and hefty load fees.
- By nature, target funds are also too conservative. Generally, an investor will simply choose just one company and one target date fund for the majority of their portfolio, or for an investment in an employer-sponsored investment vehicle. Often, fund managers have too much capital, or they are too afraid to take risks because a large portion of investments are in fixed income. A savvy investor should never be investing in mutual funds that keep large portions of investments in cash. Why pay 1% – 2% a year simply to invest in CDs and treasuries that can be purchased at a bank without sales loads?
Target date funds are simply too good to be true. “Set and forget” investing does not come without added costs. These funds are not out to benefit the investor as much as the firm that manages the portfolios.