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Target Date Funds- Right On, Or Off Target?

Target Date FundsTarget date funds allocate assets towards retirement at a defined date.  So rather than re balancing the portfolio yourself over time, the fund managers do it for you.

The problem with target date activity overall, in my opinion, is the fundamental philosophy of lowering risk as you get close to retirement.  ‘Rules’ like the Rule of 100, whereby 100 minus your age should equal your equity allocation, have been around for years.

But I believe risk should be lowered faster- your highest risk point is the 5 years prior to retirement and the first 5-10 years of retirement.  This is the time period when you have the most assets, when you have the most to loose, and when the amount of income you can safely take out each year becomes set into lifestyle patterns.

Invested in 40-50% equities and 50-60% in bonds at age 50 to 60 leaves an awful lot of money at risk- these low rates mean bond yields are incredibly low, and any slight uptick can be devastating on bond prices, evaporating your assets.

What’s my antidote? My Retirement Thesis is this: cover your Guaranteed Expenses – your baseline needs-  with guaranteed income.  Allocate enough of your assets to cover those necessary expenses with guaranteed income.

Then, with your bases covered, you can optimize the remainder portfolio for growth, to counter inflation, to take risks, and take rewards.

What this does is put you in a much safer overall position, yet allocated towards growth.  Take your money ‘off the table’ and make it produce the income you need, safely.  Then work with the rest to grow.

Now that that is out of the way, what’s a target date fund anyway?

But even as dollars pour into such funds, the asset-management industry continues to debate how best to design the funds for their central mission: generating enough asset growth, even through stretches of poor stock-market performance, to tide over investors through their entire lives.

Some managers have been altering key features of funds, such as how much the equities allocation drops by the target date. (That gradual reduction in stock exposure until and beyond the target date is termed the “glide path” that a fund follows.)

Others are investing in assets that have low correlations to stocks, such as commodities, real estate and absolute-return strategies. Some feature more active portfolio management, trying to reduce the impact of stock volatility.

Professional market observers see nothing amiss in having a wide range of approaches. Some believe it serves the marketplace to have these similar products with a wide range of strategies.

“I don’t think there is one right solution—the various approaches all have intellectual validity,” says Josh Charlson, a senior mutual-fund analyst at Morningstar Inc.

The problem, though, is it may take a long time before it’s clear which approach is going to work best. And meanwhile, the diversity in target-fund strategies makes it tough for individual investors and sponsors of defined-contribution plans—where target-date funds are widely held—to compare fund performance, evaluate the potential risks and choose among different management styles.

Despite that uncertainty, money is flowing into target-date funds at a brisk pace. Their assets now total around $400 billion, more than five times the amount at the end of 2005, according to Morningstar. Growth took off when the federal government in 2007 began allowing plan sponsors to use target funds as their plans’ default investments—the vehicle in which an employee’s dollars are invested if he or she doesn’t actively select one or more options.

Source: WSJ

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“For all time periods and for all portfolios, the addition of the annuity leads to a decline in the portfolio failure rates.”

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