Benjamin Beck, CFP®Just the other day, a friend called to tell me about a conversation she overheard.
She was in line at a local store and, knowing my fascination with both the financial world and the psychology of how people interact with money, she felt she had to share it with me right away.
She overheard two men, likely in their 40s or early 50s, discussing their retirement plans with an air of confidence. One proudly mentioned that he was "set up well" because he was invested in a "special fund that decreases my risk each year as my retirement date approaches." He was thrilled about the minimal involvement required on his part, convinced that he was all set for his golden years.
Listening to this, my friend couldn't help but think about all the misinformation swirling around in the investment world.
What struck me most about this story was how confident the man was in his position, not realizing how detrimental his chosen investment — a target date mutual fund — can be over the long term to his financial health.
This conversation epitomizes a widespread issue: many people are lulled into a false sense of security by investment products that promise simplicity and safety but ultimately undermine their financial futures.
What Is a Target Date Fund?
First, let's simply define what they are.
Target date funds, also known as glide path funds, are mutual funds or exchange-traded funds that automatically adjust the asset mix of stocks, bonds, and other investments based on a selected time frame.
The idea is straightforward: as the target date approaches — typically the year you plan to retire — the fund gradually shifts its allocation from what are commonly thought of as higher-risk, higher-return investments like equities to lower-risk, lower-return investments like bonds.
The Dangerous Illusion of the Best Target Date Fund
These funds arrived on the scene in the early 1990s but gained significant popularity after the Pension Protection Act of 2006.
This legislation encouraged the inclusion of target date funds in employer-sponsored retirement plans like 401(k)s by providing them with a "qualified default investment alternative" status.
They were designed to simplify retirement investing by offering a one-size-fits-all solution, appealing to investors who preferred a hands-off approach. The financial industry marketed them heavily as a convenient way to achieve appropriate asset allocation without the need for ongoing management or financial expertise.
On the surface, that doesn't sound half bad, right? An investment that I don't have to pay attention to that will get me to where I need to go financially? Sign me up!
No. Don't sign up. Run away. Here's why:
4 Myths About Target Date Funds You Need to Stop Believing Right Now
1. The Flawed Notion That Everyone Should Become More Conservative Over Time
Who decided that as we age, we should automatically shift from growth-oriented investments to ones that pay a fixed rate of interest?
This outdated thinking doesn't account for the reality of increasing life expectancies. Given that people are living longer than ever, we need to question whether the typical equity-to-bond mixes used in target date funds — starting from 80/20 and moving to 40/60 or even 20/80 as retirement approaches — make any sense.
Aren't these figures, which are so commonly used in the investment world, a bit out of date?
Perhaps it's time to ask: Do these allocations truly serve our best interests? With rising life expectancies, investors might be better off maintaining a mostly equity portfolio longer into their careers and even after retirement.
History shows that over any reasonable long-term horizon, the compounded returns of equities with reinvested dividends are likely to exceed those of a bond-dominated portfolio.
By automatically becoming more conservative, you're sacrificing the growth needed to sustain you through decades of retirement. Life doesn't slow down after 65; in many respects, it accelerates. Medical advancements mean we're living longer, more active lives. By dialing down your investment aggressiveness, you're essentially signing up for a future where your money might not keep pace with your life.
2. The Misguided Belief That Reducing Volatility Is Always Beneficial
Why would we attempt to protect ourselves against a "risk" that doesn't exist in the long run?
Here's the cold, hard truth: volatility — which is temporary — is the price of admission for long-term growth. The idea that reducing volatility can somehow increase your probability of success is just plain false. It's marketing fluff designed to make you feel comfortable while your potential returns dwindle.
Volatility is just short-term market movement, while risk is the likelihood of not achieving your long-term financial goals. By focusing on minimizing volatility through increased bond allocations, target date funds inadvertently increase the real risk: outliving your money.
You don't take your account balance to the supermarket; you take your income. Over time, the prices of goods and services rise — historically, the cost of living has increased nearly two and a half times over a typical 30-year retirement. In other words, what costs $1 million today would cost $2.5 million after 30 years.
Pretty crazy.
3. The Erroneous Assumption That Your Retirement Date Is an Actual Destination
Retirement isn't the end of the road; it's a new journey that could last 20, 30, or even 40 years. Planning as if your financial needs cease the day you retire is not just naive, it's dangerous.
Inflation doesn't retire. Healthcare costs don't retire. Your desire to live fully certainly doesn't retire. By treating retirement as a financial finish line, you're setting yourself up for a future of limitations.
4. The Misconception That You're Not Diversified If You're Only Invested in Equities
Yeah, that’s just not true.
Diversification isn't about owning a little bit of everything; it's about owning a finite mix of the right things. Equities offer a vast landscape of diversification opportunities — across industries, geographies, company sizes, and more.
By unnecessarily incorporating bonds into your portfolio under the guise of "diversification," you're diluting your growth potential and thereby meaningfully increasing your risk.
How's that for a big swing and a miss?!
A Reality Check: The Cost of “Playing It Safe” With Target Date Retirement Funds
Let's break it down.
Two investors, both 65, each with $2 million:
- Investor A entrusts his future to a target date fund with 60% bonds and 40% equities.
- Investor B takes the reins with a 100% diversified equity portfolio.
Let’s assume average annual returns of 10% for equities and 6% for bonds, and accounting for 3% inflation, both withdraw $80,000 annually, increasing with inflation.
After 30 years:
- Investor A is likely facing the grim reality of depleted funds.
- Investor B could be looking at an account balance of over $3 million.
That's not just a number; it's the difference between scraping by and thriving. It's the ability to say "yes" to opportunities, to care for loved ones, to live outside the shadow of financial insecurity.
Now, I would never minimize the emotional toll that setbacks in equity values — however temporary they may be — can take on an investor, particularly a retired investor.
Coaching clients to remain disciplined through these difficult episodes, so that they don’t veer off course — THIS is the reason I do what I do.
Financial Clinic: Beck Bode’s 4 Steps To Successful Planning For Retirement
Here's how to seize control:
1. Define Your Most Cherished Financial Goals
Get crystal clear on what you want. Not some vague notion of "a comfortable retirement," but specific, tangible goals. Don't be vague — it is the enemy of achievement.
2. Quantify Your Financial Needs
Don't rely on rough estimates. Do the hard math. Calculate the real cost of your goals, considering inflation and your expected lifespan. Precision now prevents pain later.
3. Map Out a Real Plan
This isn't a drill. Determine the exact steps needed to reach your goals. Identify how much to save, what returns you need, and the timeline. Wishful thinking won't cut it.
4. Fund Your Plan with the Right Investments
Choose assets that have the potential to deliver the returns you need. Hint: That's not target date funds or bonds. It's hard to argue with a century of market data showing the significant protection of purchasing power that equities provide and bonds do not.
The Real Danger Lies in Complacency
I'm glad my friend called to share her experience with me. If nothing else, it prompted me to write this article with the hope that at least one more person avoids falling into the trap of target date funds.
The man in that store represents countless others, comfortably unaware that they're on a path to potential financial shortfall. Don't be one of them.
The cost of ignorance is too high.
Ben Beck is Managing Partner & Chief Investment Officer at Beck Bode, a deliberately different wealth management firm with a unique view on investing, business and life.
