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Question:


My company 401(k) defaulted my contributions into a target-date fund. How does a target-date fund work?
-JB Good


Answer:


An ancient bit of wisdom holds that as you get older, you should maintain a smaller proportion of your assets in stocks and more in bonds because stocks tend to have bigger price swings. A heavy allocation to stocks raises the odds that you’ll suffer a loss just when you need that money to cover expenses in retirement, leaving you less of a chance to recoup the shortfall when the market recovers, as it always has done. To this way of thinking, it’s better toward the end of your working life to increasingly sacrifice the growth that stocks offer in order to assume less risk. A target-date fund is a mutual fund that puts that theory into practice by holding stocks and bonds and continually adjusting down the weighting in stocks and putting more in bonds ahead of a target date that is assumed to be when shareholders will retire and start withdrawing money from the fund. So a fund with a target date of 2050, say, might have 90 percent of assets in stocks, while a 2020 fund might have a 60-40 or 50-50 mix.
It seems like a reasonable idea, except that some funds that had target dates not that far in the future suffered substantial losses during the 2007-09 bear market, even though they should have been protecting their shareholders from exactly that sort of event. That development highlights another shortcoming that some investment advisers find in the funds. The right blend of assets isn’t just a matter of how old you are but the relative valuations of stocks and bonds. By almost every criterion, stocks were overvalued in 2007. Whether an investor is due to retire next week or in 40 years, the prudent move was to reduce exposure to stocks. Another drawback is that retirement lasts a lot longer than it used to. The notion of owning stocks, to some degree or another, and then downshifting into bonds and cash is deemed somewhat old fashioned these days. If you’re 65, there’s a good chance that you and/or your spouse will make it past 90, so your retirement fund is going to have to keep growing so that it doesn’t run out before you do.

-Conrad de Aenlle



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