Target Date Funds Are Not The “Set it and forget it” After All

Target Date Funds Are Not The “Set it and forget it” After All

Since the advent of Target Date funds in 401(k) plans their usage has exploded. Created as a way of mixing traditional asset allocation with an end retirement date, the belief was that participants could avoid the hassle of selecting their own funds but know that the allocation would glide into retirement safely. Unfortunately, there have been hiccups along the way.  The biggest issue might be that the glide paths of how the funds reduce risk over time is different from one company to the next. Compounded with the misconception that many participants think at retirement the fund will no risk, participants nearing retirement who have all of their funds in the Target when the stock market is down sharply, may suffer unwelcome losses at the wrong time. To be clear, the objective of most Target Date funds is to be approximately moderate risk at retirement. 

What’s the solution? I have determined that having a liquid cash, short term bond or fixed interest account with a minimum of two years of income need at retirement will for the most part, eliminate this risk. This can be done in several ways, making an exchange from the Target to the liquid account prior to retirement or by adding a portion of new contributions starting 5 years from retirement. Let’s give you an example: Let’s say you are single and expect to retire in five years and need $60,000 per year to retire comfortably. You plan to collect Social Security and a small pension which total $45,000. Therefore, you will plan to take $15,000 from your retirement savings. If you add $3000 per year for your last 5 years you will accumulate $30,000 plus interest, which is the two years of needed income. This will give the  stock market a chance to recover so that you can avoid selling any of the Target Date fund when the market is down. This also means if you plan to keep the fund in retirement, you have to continually replenish the liquid bucket to prevent the same issue occurring during retirement.