New Study on Target-Date Funds

Target-date funds have attracted a lot of attention of late. They are designed to manage asset allocation based on age by mixing bonds and stocks to create a portfolio for people who plan to retire at a specific time. The fees are somewhere between the low ones charged by most index funds and the higher fees assessed by most actively-traded mutual funds.

Intuitively, these funds are appealing. Many people have similar risk profiles. It makes sense to group investors by time horizon so that experts can manage the asset allocation and related risk/return characteristics. Though those argument have something to them, there are also problems. Many investors view these funds as low risk, assuming the fund's value is sure to peak on a given date (in the year 2020 for a "Target Date: 2020" fund, for example). Like any investment there is fluctuation and risk. Often more than investors realized. As a result, it is hard to predict how it's value will change over time and impossible to guarantee when it will be greatest.

Also of concern is that the allocations vary dramatically from one investment manager's product to another's. Some funds are heavy into stocks even as the target date approaches. Others are overly conservative even as that date is still far away. What's more, it seems that the modeling for withdrawl patters used by the managers is often not quite right. Investors are drawing funds more quickly than expected after retirement--about four times as fast. This creates a mis-allocated portfolio at the fund. Pensions and Investments has a good article covering the issue of faster withdrawals and their impacts. It looks at a recent study on that topic by Mercer and its implications.