Does ‘set it and forget it’ work for retirement savings?
Inventor and TV pitchman Ron Popeil became famous for his Ronco rotisserie oven, selling well over 8 million units in the United States alone.
Although “set it and forget it” is a great idea in the kitchen, that is perhaps less the case when it comes to retirement savings.
The premise behind target date funds, the financial services industry’s set it and forget it, is pretty straightforward. Generally for retirement, though sometimes also for education funding, TDFs are investment products constructed of exchange-traded funds or mutual funds, that start with an aggressive asset allocation that becomes increasingly more conservative as investors near their targeted retirement.
For younger investors with a long investment time horizon, the asset allocation mix is heavily weighted toward equities for their greater appreciation potential, becoming more balanced over time and leading to a heavy allocation toward fixed income as the target date approaches. For most investors, this approach follows conventional wisdom.
For those who have started saving for retirement but are unsure how to invest and are unlikely to periodically rebalance their portfolios and even less likely to adjust their asset allocation over time, TDFs might be an ideal set-it-and-forget-it solution, as they eliminate the burden of what for many are difficult decisions.
By their nature, TDFs are designed with the assumption that the path to retirement is somewhat linear and predictable, which of course, is rarely the case, because of divorce, illness, unemployment, etc. They also don’t address major retirement considerations, such as the individual’s savings rate, the cost of funding a comfortable retirement, and the availability and allocation of other sources of retirement funds. TDFs often are excellent options within, say, 401(k) and other tax-deferred vehicles, but they are not a substitute for a retirement plan built around one’s specific circumstances.
TDFs vary considerably among investment firms, as each provider has its own unique approach to constructing an asset mix, particularly as to the rate of reallocation and corresponding long-term capital market assumptions. They also vary considerably as to fees, and outside tax-deferred vehicles and tax efficiency, which can seriously affect returns.
For those who strongly ascribe to passive management, TDFs can be the quintessential passive investment, as they rarely engage in active management staples, such as volatility management, market cycle shifts, and the unique needs of individual investors.
For investors seeking a set-it-and-forget-it approach to funding retirement, TDFs can be a terrific investment vehicle to meet this need, while more complex financial situations may dictate a more comprehensive and dynamic approach to financial planning.
This story is part of a 30-30 series on navigating the growing world of choices for client portfolios.