TDF or "lifestyle" funds were meant to be a one-time purchase. Embedded in 401(k)s, they were designed to lower stock market risk before and during retirement.
As a pre-assembled "fund of funds," TDFs promised to put your retirement saving on autopilot. They picked the mutual funds, you picked the date or year you wanted to retire. Easy peasy, right?
Like self-driving vehicles, TDFs are still loaded with bugs. Some take too much stock market risk. Some not enough.
What happens if a bear market tanks your stock holdings a year or two before retirement?
Will you have time to recover?
The lion's share of TDFs are sold by the mutual fund titans Fidelity, Vanguard and T. Rowe Price, although every mutual fund company offers them.
Their mixes of stocks and bonds can vary greatly, depending upon the company and target year.
I know you want to put your TDF on autopilot. Most do because investing can get complicated and many don't want to deal with the subject.
Yet every TDF manager is different in subtle ways. They could be taking more risk than you can stomach by ramping up stock investments.
Fidelity, which offers a series of "Freedom" TDFs, "has substantially increased exposure to stocks, including those from volatile emerging markets," according to Reuters.
Why is that a potential issue?
"Such changes have worked well in the second-longest running bull market in U.S. history, but they expose investors to bigger losses if the funds’ increasingly volatile assets head south."
Ron Surz, president of Target Date Solutions, a company that designs "smart" TDFs, has been sharply critical of conventional TDFs for years.
“These funds with high concentrations in stocks are a time bomb,” Surz told Reuters.
Responds Fidelity spokesman Vincent LoPorchio: American savers are retiring later, therefore they can handle more risk.
“The Freedom Funds are a lifetime savings solution,” he said, that “deliver exceptional performance for shareholders taking appropriate risks.”
How You Can Protect Yourself
The easiest thing for you to do is to identify the different kinds of risk in your portfolio and ask yourself if your TDF's risk level is right for you.
Here are three questions to ask your 401(k) administrator or fund company:
-- How much market risk are you taking within five years of your target or retirement age?
If the stock mix is more than 70% in that time frame, you could get nailed by a bear market.
-- How much bond-market risk are you taking?
Shifting most of your money into bonds near retirement is risky as well. If interest rates or inflation climb, then bonds lose value, especially those in mutual funds.
The longer the maturity of the bonds in the portfolio, the more you stand to lose.
-- Are you going to actually retire on the target date? Many won't or may leave the workforce early. If you have to work longer, that will impact the amount of risk you need to take.
And if you're disabled or chronically ill, you may need to be more heavily invested in cash vehicles like money market funds.
Whatever you do, don't plug into these funds and forget about them.
They are like space heaters. You don't walk to walk away from them.
