One of the drawbacks to Target Date Funds is that asset allocations are predetermined and change very slowly over time. Thus, Target Date Funds are unlikely to reflect the optimal investment opportunities at any given time.
For example, the Vanguard Target Date 2060 Fund listed above would be appropriate for an investor with about 40 years until retirement. The current asset allocation exhibits an International Stock allocation of about 35%. This predetermined allocation does not account for current market conditions or a portfolio manager’s outlook, which may contrast with the static target weighting scheme. If, for example, an investor’s view is that U.S. equity markets will be stronger than international markets, they may favor a 20% international allocation, which is a material underweight exposure relative to the Target Date 2060 Fund.
Alternatively, the Total Stock Market fund holds about 8.3% of its assets in smaller companies, or about 4.6% of the Target Date 2060 (as the holdings are based upon market cap). This same investor’s view might be that small and mid-cap equities will provide strong performance in a current market cycle and would want to hold closer to 15% in small and mid-cap equities—an overweight to the Target Date 2060 Fund.
The Target Date approach of “set it and forget it” comes with the opportunity cost of not being able to tailor an investment strategy to account for current market conditions. Some 401K plans offer many Target Date Fund options, but very few other investment options such as mutual funds or ETFs. For this investor, understanding the underlying asset classes of the Target Date fund and investing in other funds (through IRAs and taxable accounts) will allow them to position the portfolio differently than these “locked in” positions in order to produce an overall portfolio that is more in line with the investor’s outlook.
Blindly following “simple” investment strategies can lead to unintended and suboptimal results. It is important for every investor to truly understand what is “under the hood” of each investment strategy so that smart portfolio decisions can be made. At Round Table Wealth Management, we manage our client portfolios with a mix of passive index strategies and actively managed investments. Importantly, we coordinate the underlying holdings of each to achieve the desired results.
Please contact your Round Table Wealth Management Advisor for further information.