AUDIO: Target-Date Funds for (and of) the Next Generation

I’ve written about target-date funds before, explaining that they’re essentially 401k plans on autopilot. All you do is pick the fund with the year in its name closest to the year you hope to retire, and whoever is running the fund picks stocks, bonds and sometimes other assets that have a level of risk appropriate for the number of years you have until retirement, adjusting the holdings accordingly as you go.

youngInvestorsB.pngA 21-year-old planning to retire at age 65, for example, might want to be in the Vanguard Target Retirement 2055 Fund (VFFVX).

I recently chatted with Tim McCabe, the head of Stadion Money Management — an investment firm that has been in the retirement space for almost 20 years. Stadion prides itself for being at the forefront of the target-date fund evolution, as the firm calls it, thanks to its adjustable glide path target-date products.

See, each fund that Stadion offers has its own “flex” area where the manager can adjust a portfolio’s distribution between equity and fixed income depending on market conditions. As Stadion puts it: “It’s impossible to know what the market will do in 20, 30 or 40 years. Does it makes sense to have a target-date fund that doesn’t adjust itself depending on market conditions?”

McCabe and I talked about the new product, along with target-date funds in general. He agrees that target-date funds can be a crutch for investors who don’t yet know what they are doing … but, bluntly speaking, he thinks there are a lot of crippled people out there.

So for folks who don’t have the knowledge or time to build a correctly balanced portfolio, target-date funds remain a great option. In fact, he believes they are an especially good option for the up-and-coming generation. Here’s a quick explanation from McCabe as to why:

“Young investors are scared of risk. They tend to be pretty conservative with their money. Our fund has a flexible glide path to reduce downside volatility — losing as much money when the market’s down. It still has a 50% equity floor, but it’s more conservative.

That’s important to help young investors to stay the course. There’s research out there that shows people get to a certain point and bail out, but when they bail out, they do it at exactly the wrong time. They bail out at the bottom, then miss the gains coming back up. If we can limit their downside volatility where it’s not as painful, they tend to stay the course and will be better off long-term.”

Listen to the full audio above. Also, you can read more about the “to vs. through” distinction (which McCabe mentions briefly in the interview).

Alyssa Oursler is an Assistant Editor of InvestorPlace. Follow her on Twitter at @alyssaoursler.

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