The problem with easy answers is that easy answers aren’t always the best. The investment industry has many product manufacturers eager to pounce on any rising investor concern with a convenient prepackaged answer that seems to solve their most pressing problem.
Many 401(k) participants seeking an easy way to pick the funds that will let them retire on a given date have jumped on target-date funds (TDFs) as the answer. These funds became available to investors as a qualified investment alternative under the Pension Protection Act of 2006; but, since the market losses of 2008, many have been wondering just how predictable achieving a successful retirement can be using TDFs.
What if, in 2008, you had been in a TDF with a target date of 2010 – just two years away? According to Ibbotson, your losses could have ranged from -3.5% to -41.3%, depending on which 2010 TDF you chose.
When you think about it, a TDF isn’t much more than a “balanced fund” – I love that term; no one knows what it means – that is supposed to be continually rebalanced to a lower risk allocation as you approach retirement. But, if that’s all it is, why not just simply create your own allocation – using professional help or some sophisticated planning software, of course – and rebalance as you go through your periodic investment reviews?
Those approaching retirement often have substantial investments in TDFs. They may want to evaluate the suitability of their stock allocations. While many studies have indicated that stock allocations toward the higher end of the range offered in TDFs provide better retirement outcomes, many may be concerned about short-term volatility, giving them a ride they may not enjoy. Meanwhile, the decreasing equity allocations over the course of retirement, while it may feel comforting, doesn’t appear to improve retirement outcomes.
Those investors may find fixed annuities might serve as bond substitutes and also reduce the risk of outliving one’s savings. Substituting fixed annuities for bonds can reduce overall volatility and thereby support higher stock allocations without undue risk of failure.
Remember, characteristics such as age, marital status, required withdrawal rate, and other sources of income such as Social Security must factor into what works best in individual cases.
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Jim Lorenzen is a CERTIFIED FINANCIAL PLANNER® professional and An Accredited Investment Fiduciary® in his 21st year of private practice as Founding Principal of The Independent Financial Group, a fee-only registered investment advisor with clients located in New York, Florida, and California. He is also licensed for insurance as an independent agent under California license 0C00742. IFG helps specializes in crafting wealth design strategies around life goals by using a proven planning process coupled with a cost-conscious objective and non-conflicted risk management philosophy.
The Independent Financial Group does not provide legal or tax advice and nothing contained herein should be construed as securities or investment advice, nor an opinion regarding the appropriateness of any investment to the individual reader. The general information provided should not be acted upon without obtaining specific legal, tax, and investment advice from an appropriate licensed professional.