Before we can answer the question of whether or not we should buy target-date funds, we first have to define what target-date funds are.
Target-date funds have selected dates at which time the assets will be liquidated. Target-date funds automatically reset their asset allocations of stocks and bonds based on the amount of time left before their liquidation dates arrive — hence the term “target-date.”
Since stocks are generally riskier than bonds, most target-date funds are weighted more towards stocks in the early years of the fund and gradually increase the bond weighting as time goes on. The idea is that as your target-date funds reaches its final destination, you’ll want to be risking less and focusing more on capital preservation.
Some investors like this because it is an emotionless, mechanical model. Others like the simplicity of the strategy. There are plenty of ways to interpret past performance and skewing it to be very positive based on the start date and target date.
If you have a target-date fund that launched post-1987 crash in 1988, with a 10-year target date, then it obviously missed the dot-com bubble popping, the 9/11 correction and the financial crisis.
I generally don’t like the target-date funds strategy, though, because it’s “one-size-fits-all.” Target-date funds don’t speak to individual risk tolerance. The very fact that they are mechanical means that more savvy investors may miss out on opportunities to re-allocate capital depending on certain market or sector conditions.
Let’s say you are an expert in semiconductors. You notice some big changes in the sector that entice you to go long or short. If all your money is tied up in target-date funds, then you are missing out.
Perhaps you notice a change in a given stock or even the entire market that gives you reason to believe the entire market will surge higher in the next few weeks, but if you are in the later stages of target-date mutual funds, you’ll miss out.
On the opposite side, what if you are in the early years of some target-date funds, and the market corrects one day, and you think it’s going to get worse. Why stay in equities?
The trick here is that emotion can work to your advantage if you are wise and savvy, but don’t let emotions control your behavior. One of the facts of my forthcoming newsletter, The Liberty Portfolio, is that I have a crash protocol. I have hedging strategies designed to blunt a market crash, whereas one doesn’t get that if they are in target-date mutual funds.
As humans, we want the option to be nimble in the markets. Why lock yourself into one strategy? There’s a reason we have exchange-traded funds now. If you want to invest in the S&P 500, you can invest in SPDR S&P 500 ETF (NYSE:SPY) and even short it with ProShares Short S&P 500 (ETF) (NYSE:SH) if you suddenly decide to hedge.
Or maybe you think Apple Inc. (NASDAQ:AAPL) is headed higher. Then buy AAPL stock. Don’t assume your target-date funds carry it.
That’s not to say that target-date funds don’t have any place in your portfolio. Like all long-term diversified portfolios, you should have your capital spread around. You might consider placing a percentage of your holdings in various target-date funds to not only give you exposure to this strategy, but also to choose several different dates for your targets, to diversify that element as well.
Lawrence Meyers owns shares of AAPL.
