That simplicity can be useful. It also comes with trade-offs. A target date fund follows a predetermined allocation path based largely on an anticipated retirement year, which may or may not reflect an individual investor’s financial circumstances, risk tolerance, or retirement goals.
Four limitations to understand
The Illusion of Simplicity
A single retirement year cannot capture every investor’s financial circumstances, goals, or comfort with risk.
Limited Flexibility
A predetermined glide path continues to adjust according to schedule even as market conditions and an investor’s circumstances change.
A Glide Path That May Not Fit
The increasingly conservative allocation used by many target date funds may not provide the right balance of growth and stability for every investor.
Look Beneath the Target Year
Funds with the same target year can hold materially different allocations, and the year alone does not tell an investor exactly what they own.
The Illusion of Simplicity
Target date funds are designed to automatically adjust their asset allocation as an investor approaches retirement, typically becoming more conservative over time. That convenience can be valuable, but retirement planning is highly personal, and a retirement year alone does not capture the full picture.
One-Size-Fits-All Approach
- The investment strategy is based primarily on an anticipated retirement date.
- It does not account for each investor’s unique financial circumstances, risk tolerance, or retirement goals.
- The resulting allocation may be more conservative or more aggressive than the investor would otherwise choose.
Lack of Personalization
- Investors with the same retirement year can have very different needs, goals, and risk tolerances.
- A high-income earner with substantial savings may be comfortable with more equity exposure near retirement.
- An investor with a lower risk tolerance may prefer a more conservative allocation earlier.
Limited Flexibility as Conditions Change
Target date funds generally follow a predetermined glide path, gradually shifting from stocks toward bonds as the target date approaches. That structure can reduce the need for ongoing investment decisions, but it also limits customization as conditions change.
Predetermined Glide Path
- The allocation changes according to a preset schedule.
- The fund does not make individualized adjustments based on an investor’s changing circumstances.
- In environments such as high inflation or low interest rates, the role of bonds in the portfolio may deserve closer review.
Limited Flexibility During Market Changes
- The fund continues to follow its predetermined path regardless of short-term market conditions.
- A more flexible strategy may allow an investor to reconsider risk exposure as conditions evolve.
- Greater flexibility does not guarantee better results, but it can allow the portfolio to remain more closely tied to the investor’s broader plan.
When the Glide Path May Not Fit
As retirement approaches, many target date funds gradually reduce equity exposure. For some investors, that may be appropriate. For others, the resulting allocation may become more conservative than their long-term retirement plan calls for.
The takeaway is not that target date funds are inherently inappropriate. It is that the glide path is designed as a broadly applicable solution rather than around one investor’s complete financial picture.
Longevity Risk
Many retirees need their portfolios to continue growing well into retirement. For some investors, an increasingly conservative allocation may provide less growth exposure than their retirement income plan requires, potentially increasing longevity risk, the risk of outliving one’s savings.
Look Beneath the Target Year
Target date funds can also require a closer look beneath the target year printed in the fund name. Their underlying holdings, glide paths, and assumptions can vary significantly across providers.
Look Beyond the Fund Name
- Target date funds often invest in other funds, creating a fund-of-funds structure.
- Investors may need to review the underlying allocation to understand what they actually own.
- The structure can make it harder to assess the portfolio’s true level of diversification at a glance.
Same Date, Different Portfolios
- Two funds carrying the same target year can hold materially different allocations.
- Providers use different assumptions about risk and what happens after the target date.
- Selecting a fund by year alone may not reveal how much equity risk the investor is actually taking.
Alternatives to a Static Target Date Fund
For investors who want more control or personalization, employer-sponsored retirement plans may offer other ways to build and manage an allocation. The right choice depends on the options available in the plan and the investor’s own goals, risk tolerance, and financial situation.
Consider Model Portfolios
Some employer-sponsored retirement plans offer model portfolios, pre-designed investment strategies that combine a diversified mix of assets for different risk tolerances and investment goals.
Key Features
- Diversification: Model portfolios combine multiple asset classes around a defined risk and return objective.
- Risk-Based Options: Many plans offer conservative, moderate, and aggressive choices.
- Automatic Rebalancing: Some model portfolios periodically rebalance to maintain their intended allocation.
Potential Benefits
- Simplicity: Model portfolios can reduce the number of investment decisions a participant needs to make.
- More Choice: Participants can select an allocation based on risk tolerance rather than retirement year alone.
- Time-Saving: The portfolio can provide a structured starting point for participants who do not want to manage every underlying fund themselves.
Considerations
- Limited Customization: A model portfolio still may not fit as closely as a fully individualized strategy.
- Periodic Assessment: Participants may need to revisit their risk tolerance and goals over time.
- Plan Rules: Some plans limit whether model portfolios can be combined with other investment options.
Choose Your Own Investment Allocation
Investors who are comfortable managing their retirement investments can build a portfolio from the options available within their employer-sponsored plan. This can provide more control over the mix of investments, but the quality of the outcome still depends on the plan lineup, the investor’s knowledge, and whether the portfolio is reviewed and rebalanced over time.
Considerations:
- Customization and investment knowledge: The amount of control available depends on the number and type of investments offered by the plan and the investor’s ability to evaluate them.
- Periodic assessment: Risk tolerance, goals, and the investment mix may need to be revisited over time.
- Plan limitations: Some plans restrict how different investment options can be combined.
In-Service Withdrawals and Managed Account Options
Some employer-sponsored retirement plans permit certain in-service distributions, subject to age, plan terms, and other eligibility requirements. If a distribution is eligible for rollover, it may be transferred to another eligible retirement account. The available options should be confirmed under the specific plan before taking action.
For investors nearing retirement, an in-service withdrawal may provide access to a broader investment menu or professional management through an IRA. It is still a rollover decision and should be compared carefully with the alternatives available inside the employer plan.
- Leave the assets in your current employer plan. Depending on the plan, remaining in the employer plan may provide access to competitively priced investment options, plan-specific services, and creditor protections that differ from those available in an IRA. For some qualified plans, distributions taken after separating from service in or after the calendar year in which the participant reaches age 55 may also qualify for an exception to the 10% additional tax on early distributions; that particular exception does not apply to IRAs.
- Roll to a new employer’s plan, if you change jobs and the new plan accepts rollovers. Investment options, fees, services, withdrawal rules, and other features may differ from the prior plan.
- Roll to an IRA. This can broaden investment choice and permit professional management, but it may involve an additional advisory fee, creditor protections that differ from those available in an employer plan and may vary by state, and the loss of the age 55 separation-from-service exception described above.
- Take a taxable distribution. The taxable portion of a distribution is generally included in ordinary income for the year and, depending on age and circumstances, may also be subject to the 10% additional tax on early distributions.
Finivi is compensated for managing assets in an IRA and is not compensated on assets that remain in an employer plan. That creates a conflict of interest, which is why any rollover comparison should be based on the specific features, costs, and circumstances of the investor’s own plan.
Some plans also offer a self-directed brokerage window. Depending on the plan’s rules, this can broaden the investments available while assets remain inside the employer plan. Some arrangements may also permit professional management through a third-party registered investment adviser, while others do not. Availability, eligibility, costs, permitted investments, and access to outside management vary by plan.
Potential Advantages and Trade-Offs
What greater flexibility can change
Expanded Investment Options
In-service withdrawals and self-directed brokerage windows can increase the range of investments available beyond a plan’s standard menu.
Professional Management Opportunities
Some investors may value having retirement assets managed by a professional rather than making every investment decision themselves.
Personalized Investment Strategies
A professionally managed strategy can be built around an investor’s specific goals, risk tolerance, and investment horizon.
A Wider Opportunity Set
A broader menu can make strategies available that are not offered in a standard plan lineup. More choice does not, by itself, improve results.
Risk Oversight
Professional management can provide ongoing attention to diversification, asset allocation, and changes in the investor’s circumstances.
Ongoing Adjustments
Unlike a predetermined target date glide path, an individually managed account can be reviewed and adjusted as circumstances change.
Cost Considerations
Professional management may add an advisory fee in addition to underlying investment expenses. Employer plans and target date funds also have costs, so total expenses should be compared before assets are moved.
Greater flexibility can be useful, but it also creates more decisions. The goal is not to maximize complexity. It is to choose a level of simplicity, control, and oversight that fits the investor’s broader retirement plan.
The Bottom Line
Target date funds can be a useful solution for investors who value simplicity and automatic rebalancing. Their limitation is that the same simplicity also means less personalization. A predetermined glide path may not reflect every investor’s financial circumstances, risk tolerance, or retirement goals.
For investors who want more control, several alternatives may be available within or alongside an employer-sponsored retirement plan.
Model Portfolios
Some employer-sponsored plans offer model portfolios that can be selected based on an investor’s risk tolerance and investment goals rather than retirement year alone.
Custom Asset Allocation
Investors can research and choose their own mix of available investment options within the employer-sponsored retirement plan.
Professional Management Options
For eligible participants: An in-service withdrawal, if the plan permits it, may allow some retirement assets to be transferred to an IRA for professional management.
For plans that offer one: A self-directed brokerage window may broaden investment choice and, depending on the plan’s rules, allow professional management while assets remain inside the employer plan.
No approach guarantees a particular retirement outcome. The purpose of comparing these options is to determine which structure best aligns with the investor’s own needs, goals, and plan features.
For help coordinating workplace retirement investments with your broader retirement strategy, explore Finivi’s retirement planning services →
Sources
- Aron Szapiro, Morningstar, “Target-Date Funds’ Glide Paths Don’t Always Match Plan Participant Needs”, July 18, 2022.
- U.S. Securities and Exchange Commission, Investor.gov, “Target Date Funds – Investor Bulletin”.
Finivi is compensated for managing assets held in an IRA and is not compensated on assets that remain in an employer-sponsored retirement plan. A conflict of interest exists whenever we describe the potential benefits of moving assets to an IRA we would manage. Any rollover decision should be evaluated against the alternatives of leaving assets in the current plan, rolling to a new employer plan, or taking a taxable distribution, based on the specific features and costs of your own plan. Plan features, including in-service withdrawal eligibility and the availability of a self-directed brokerage window, vary by plan and by employer. Confirm what your own plan documents permit before taking any action. The information provided in this article is for educational and informational purposes only. It should not be construed as investment advice or a recommendation to buy, sell, or hold any specific security or investment product. Past performance is not indicative of future results. Investing involves risk, including the possible loss of principal. Before making any investment decision, you should carefully consider your financial situation, risk tolerance, and investment objectives. We strongly recommend consulting with a qualified fiduciary financial advisor to discuss your specific circumstances and determine the most appropriate investment strategy for your individual needs and goals. Finivi Inc. is an SEC-registered investment adviser. Registration does not imply a certain level of skill or training.
