What are target date funds?
Target date funds are funds offered by investment companies that aim to grow your assets over a specified period for a specified goal. The biggest and most common financial goal for many people is retirement.
Superlife is one example of a company that offers such funds in New Zealand. They are called age step funds and have the following tilt towards growth assets (such as stocks and property):
Age 20 – 96% growth
Age 30 – 80% growth
Age 40 – 80% growth
Age 50 – 75% growth
Age 60 – 57% growth
Age 70 – 40% growth
Age 80 – 10% growth
If you are in an age step fund, as you get older, the proportion of your investment in growth assets will be reduced, to reflect the reduced timeframe before you may need access to the fund.
Who are target date funds good for?
I think these are great funds for three types of investors:
1/. Those who are always tinkering in and out of the market.
2/. Those who don’t rebalance their portfolios as they age.
3/. Those who are too scared to invest at all.
In these instances, target date funds can be truly beneficial. There is nothing easier than the set and forget nature of these funds, and if you are one of the above three investors, then these funds will probably offer you better returns than you would otherwise. You also won’t drift too far over or under an acceptable level of risk.
But……
The downsides of target date funds
These funds have a target date of retirement around age 65. Which is fine for most people who can only dream of early retirement. But those who can and do retire earlier or later than 65, these funds may not be suitable at all.
Take for example, someone planning to retire or slow down at age 50. From which point they will need to start withdrawing from their funds. Using these target date funds, at age 45 they will be invested about 80% in growth. That is far too aggressive in most people’s opinions when needing to withdraw in 5 years’ time.
Or you could have two people the same age but on far different incomes. Someone on a higher income or a more secure job can take greater risk with their investments. Someone on a lower income or with less job security, will need to be more conservative with their investments.
Perhaps they could earn the same income, but have two very different levels of annual expenditure. In retirement, the person with higher expenses will probably need to take on greater risk to have any chance of beating inflation and achieving their desired returns.
Maybe one is going to be working part time in retirement. They can take more risk than the other who has fully retired.
Or one could have some shorter-term goals such as saving for their kids education or a deposit on a house. A target date fund for age 65 will not be suitable at all. They would need a separate fund for this goal.
What if one has built up a nice KiwiSaver nest egg and the other hasn’t? The one with the higher KiwiSaver may not need access to the target date fund until much later than 65. They need more growth than target date funds provide.
Another instance could be one person is expecting a lump sum in retirement. Could be from an inheritance or a house sale. Whereas the other person is not. Same age, but two very different cashflow needs.
Someone who has a higher emergency fund can often take on higher investment risks than someone who doesn’t.
In all these examples, the people were the same age, yet their situations differed. What is a suitable target fund for one may most definitely not be suitable for the other.
Finally, target date funds are not the most efficient fund to withdraw from when it comes to decumulation.
When you are spending from your investments, it’s much more efficient having a choice to withdraw from either bonds or stocks for example. If stocks are having a bad year, your money would have better odds of lasting if you can withdraw from your bonds first, and vice versa. With a target date fund you have to withdraw from the whole fund and don’t have a choice as to what asset you sell down. So when stocks have a bad year in a target date fund you will be crystalising your losses. This will reduce the longevity of your portfolio than if you could manage your own assets separately.
Final thoughts
Target date funds could be suitable for some people, as mentioned above. But for the majority, age is not a great benchmark to use when setting up your investments. Your investments should be based on your own personal timeframe and goals. Very few people have the same goals, timeframes, and tolerance for risk.
To get the most out of any investment you need to take on just enough risk to give you the best chance of meeting your goals, but not too much or too little that you fall well short. Target date funds don’t provide this individuality. There are plenty of worse investments you can make than target date funds, but you can also do much better. If you are unsure as to how to set the best portfolio for your situation, then do see an independent adviser. They should be able to add far more value than a one size fits all portfolio can.
If you need an investment plan or recommendations , then get in touch today.
The information contained on this site is the opinion of the individual author(s) based on their personal opinions, observation, research, and years of experience. The information offered by this website is general education only and is not meant to be taken as individualised financial advice, legal advice, tax advice, or any other kind of advice. You can read more of my disclaimer here