Every once in awhile, even savers cruising on autopilot need to check their engines.
Retirement investors poured another $69 billion, a record, into target-date mutual funds in 2015, according to data firm Morningstar, bringing the category to a total of $763 billion in assets. Did someone say juggernaut?
Automatic contributions into workplace savings plans account for a big chunk of target-date funds’ growth. And by definition, the funds’ mandate is to provide a portfolio that adjusts its risk level over time, so investors don’t have to bother picking investments and rebalancing their mix of stocks and bonds. Compared with excessive trading and other investing mistakes people make, most experts say, the funds offer novice investors professional management at a relatively low cost.
Looking at investor returns, which simulate how actual investors fared in the fund using cash flows, the Morningstar team found that investors on average slightly outperformed the funds’ total 10-year return. All good there.
Some experts are warning about some turbulence on the radar, however:
The funds vary widely in how they adjust risk over time, and that could be a big problem, says Michael Kitces, director of wealth management for Pinnacle Advisory Group in Columbia, Md.
When investors are more than 25 years from the target retirement date of the funds, virtually all of the funds allocate a high percentage of assets to stocks. At the target date, however, there’s a wide gap, with funds ranging from about 60 percent stocks to less than 25 percent.
Kitces says he worries about funds that hit the target date with a high percentage of stocks – closer to the 60 percent territory – and then dial down stock exposure to very low levels by the end of retirement. The reason: Retirees drawing income off their portfolios compound any early losses and a declining percentage of stocks means little chance the nest egg can recover over time.
The speed of the stock reduction matters, too. Funds with a mandate to reduce stock exposure relatively quickly could take severe hits if those years coincide with bad years for stocks, Morningstar researchers found.
Another problem is target funds’ own success. With so much money piling into them, the report noted, managers struggle to find new investments that have room to grow.
Then there’s the growing chorus of market prognosticators warning that projected higher interest rates could crimp bond yields and high stock valuations will result in lower overall stock returns in the critical years ahead for savers within a few years of retirement and beyond. These trends will hit everyone, not just target-date investors, of course.
Finally, says Morningstar’s Jeff Holt, the funds haven’t yet tackled the mechanics of drawing income in retirement. So-called managed payout funds were designed to optimize a withdrawal strategy in retirement, but those haven’t caught on like their target-date counterparts.
“The big question mark that target date managers are still trying to figure out is retirement income,” he said. “That’s going to be an interesting” question as more investors age into retirement.
For now, realize that while you may have snoozed through the investing stage with these funds, you’re on your own to decide when, and how much, to withdraw at retirement.