Autopilot investing: The pros and cons of target-date funds
A growing number of Americans skip the opportunity to play Wall Street tycoon, opting to put their investment portfolios on autopilot instead.
The investment management heavyweight The Vanguard Group predicts more than three-quarters of its 401(k) clients will be solely invested in an automatic investment program by 2022, according to the firm’s “How America Saves 2018” report. The shift from active to passive investing is global, according to new research from the Fed, and could come with some risks, including more pressure on brokerage firms to succeed.
Building a well-diversified investment portfolio can be overwhelming. Target-date funds are popular because they simplify the process for participants, says Jean Young, senior research analyst at Vanguard’s Center for Investor Research.
Target-date funds, often a type of mutual fund, are thought of as “set it and forget it” investment options because after participants set their contribution from their paycheck and select the funds, the asset mix in the funds automatically adjusts, slowly becoming more conservative as participants get older and closer to retirement.
“That’s why target-date-funds are growing at Vanguard and all the major providers,” Young says. “It’s just simply easier for people.”
At year-end 2017, nearly 6 in 10 of all Vanguard participants were solely invested in an automatic investment program — compared with just 1 in 10 at the end of 2003 and just 2 in 10 at the end of 2007. More than half of participants (51 percent) were solely invested in a single target-date fund, according to the “How America Saves 2018” report.
Altogether, target-date funds eclipsed $1 trillion in assets in 2017 after seeing an all-time high of $70 billion in estimated net flows during the year. Ninety-five percent of the new money went toward passive target-date series that predominately invest in index funds, according to the 2018 Target-Date Fund Landscape report from Morningstar Research Services.
Pros of target-date funds
- Target-date funds are relatively easy to opt into, and many 401(k) plans automatically enroll participants.
- Fees for target-date funds are on a multiyear downward trend hitting a weighted expense ratio of 0.66 percent at the end of 2017, according to Morningstar.
- Target-date funds consider an investor’s age to create a diversified portfolio that balances risks.
Target-date funds help people wade the waters of investing, says Jennifer Shulman, owner and principal of Simply Balanced Solutions LLC, a Florida-based professional daily money management firm.
“Pretty generally, a target-date fund would be a pretty good thing to get you up and off the sidelines and into the market to take advantage of the (market) growth,” Shulman says. “Keeping your money in a CD (certificate of deposit) or savings account is pretty darn conservative, and you’re not going to make a whole lot of money.”
Long-term, people will want to see a certified financial planner for guidance on the right portfolio mix and knowledge about the limitations of passively investing through target-date funds, she says.
Cons of target-date funds
- Target-date funds aren’t always a one-size-fits-all investment option.
- Target-date funds may get too conservative too fast for some investors.
- There are financial stability concerns related to increased concentration in passive fund management.
Passive funds have helped Vanguard and other managers of mutual funds and exchange-traded funds grab a huge chunk of the investment market, according to experts at the Federal Reserve Bank of Boston and Board of Governors of the Federal Reserve System.
In the working paper “The Shift from Active to Passive Investing: Potential Risks to Financial Stability?” analysts at the Fed suggest that “a significant idiosyncratic event at a very large firm” — such as a cybersecurity breach — could lead to a massive wave of people asking for their money, leading to broader negative financial consequences for the market.
On the microeconomic level, investors might want to meet with a financial adviser or find an option that meets their individual needs, especially as they get closer to retirement.
“There’s this question: Does one size fit all? In the accumulation phase, the target-date fund does a pretty decent job when the only thing we know about you is the year you might retire,” Young says. “Ultimately, we should all have a custom solution that takes into account not just what you have in your current plan with your current employer, but your entire asset picture.”
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