Target Date Funds: Timing is Everything

Target Date Funds look to rebalance overtime without interaction. This offers an almost autopilot experience to the investor. While this may be viewed as a conversative option, there still are advantages and disadvantages to utilizing them in your financial strategies. Robert Crothers, Managing Director, Head of US Retirement for BlackRock joins Cassidy Clement to discuss.

Summary – Cents of Security Podcasts Ep. 104

The following is a summary of a live audio recording and may contain errors in spelling or grammar. Although IBKR has edited for clarity no material changes have been made.

Cassidy Clement: Welcome back to the Cents of Security Podcast. I’m Cassidy Clement, Senior Manager of SEO and Content at Interactive Brokers, and today I’m your host for the podcast. Our guest is Robert Crothers, Managing Director and Head of U.S. Retirement at BlackRock. 

Target date funds look to rebalance over time without interaction. This offers an almost autopilot experience to the investor. This may be viewed as a conservative option. There are still advantages and disadvantages to utilizing them in your financial strategies. 

Welcome to the program, Robert. 

Rob Crothers: Thanks, Cassidy. Great to be here. 

Cassidy Clement: Yeah. So since this is your first episode, why don’t you tell the listeners a little bit about your background in the industry? 

Rob Crothers: Sure. As you mentioned, I’m Head of Retirement at BlackRock. That generally, for BlackRock, means our defined contribution business, but I deal with lots of retirement problems in the U.S. and in other places. I’ve spent about 25 years in the industry—all of it at BlackRock—and done a variety of different things, either in the U.S. wealth market or working with individual investors, or prior to joining retirement, with institutional investors globally. 

Cassidy Clement: Yeah, that’s great. So you seem to be the right person for this episode. We’re going to talk about target date funds today. Just to lay the groundwork, what exactly is a target date fund and how do they work? 

Rob Crothers: Great question—in part because target date funds, I think, are somewhat poorly understood. You gave a pretty good explanation in your intro. A target date fund is a professionally managed asset allocation portfolio that shifts its asset allocation over time to become more conservative or introduce new asset classes. 

In the case of target date funds, they’re traditionally used for—or most often talked about for—retirement investors. The reason they’re called target date funds is, generally speaking, the funds themselves have a year or a date within their name. More often than not, that date corresponds to some sort of a savings-related target—say, for example, when I intend to retire, or, in the case of a birth-year-based fund, the year in which I turn 65. 

When I mention professionally managed and shifting asset allocation, generally speaking, what that means is that the risk that the funds take changes over time—starting with, for example, more growth-oriented assets, maybe a higher weighting to equities over individual bonds, and then shifting that allocation to introduce more bonds over time or to, for example, introduce things like inflation-sensitive asset classes as the portfolio gets more conservative as you get closer and closer to your target date. 

So think of it as a sort of one-stop shop for asset allocation that dynamically adjusts over time, such that individuals can invest and, over the course of their investing life, shift allocations to become more conservative. 

Cassidy Clement: Yeah, they usually tend to be referenced a lot with retirement and changes within the market towards a retirement date—as you mentioned, inflation. But can they really be invested in for other purposes, or is the main goal a retirement vehicle? 

Rob Crothers: Absolutely can be used for lots of different purposes. What we traditionally talk about when we talk about target date funds is what we call a glide path, and that’s the change in asset allocation over time towards the target date. Glide path-type asset allocation funds are used in lots of circumstances. 

We call that goals-based investing. More often than not, for example, it can be used—and is used widely—in educational savings. For example, I know 18 years after birth, ideally I’m sending a child off to college. It’s used often underneath, for example, Section 529 or educational savings plans. 

So it can be used, in a sense, for any sort of savings goal that has a fixed certain date or an approximate time period in which you’d want to take action. 

I would say one thing that we didn’t talk about at the beginning—but I think is important—is once you hit the date in a fund, it’s not like the fund goes away. 

There are two different approaches to how target date funds traditionally work. In some cases, they continue to de-risk post that date and continue to take less and less equity risk, for example, as you’ve reached your savings milestone. We call that a “through” approach—because it’s through the target date. 

In other cases, the allocation at that point becomes fixed and you move toward a sort of fixed allocation portfolio—say, maybe 40% equities, 60% fixed income. 

So think about target date funds—yes, 100% predominantly used in the retirement world. 95-odd percent of all 401(k) plans use target date funds as their default investments today because of their ease and simplicity in implementing a savings goal. 

But think about it also as a tool that can be used outside of a DC plan or outside of a 401(k), really for any savings goal—whether that’s supplemental retirement savings, or, like I mentioned before, educational savings, buying a house at some point in the future—something that you want to become more certain of in your allocation or exposure to investments the closer you get to that target. 

Cassidy Clement: So you mentioned a little bit about the makeup of the fund when you get closer to the set date, but how exactly does the fund ebb and flow when you are closer to the end versus further away from the end date? Is it more based on the risk associated? Is it impacted a lot by the external economic factors, or is it a little bit more like dollar-cost averaging, where it’s slow and steady toward the allocation? 

Rob Crothers: So the answer is: a bit of all of the above. And I say that in part because target date funds come in lots of flavors. There are some that are index implementation—that are much more sort of asset allocation-driven. And we’ll talk about that in a second, because it’s a good example of what you’re talking about. 

And there are others that are more actively managed, that, for example, might tactically manage during a specific market for its individual exposures. 

The broad form: think about target date funds as shifting asset allocation strategically over time. So I mentioned that glide path context—just walk with me here as an example. 

Say, in the retirement context, an average 20- or 21-year-old starting in the workforce—he or she may have, call it, a 95% exposure to equities. They have the longest investment time horizon, so can take the most amount of investment risk up to the point of retirement—that’s, say, 40 years or so away. 5% may be in fixed income, or perhaps as much as even 99% equities, 1% fixed income. 

That then—structurally or strategically—changes its composition over time. Target date funds typically rebalance periodically within a year. So they reallocate their assets within stocks and bonds or other asset classes, whether that’s quarterly, whether that’s monthly, or as individuals contribute more money—to the dollar-cost averaging point. 

But the crux of the construct of a target date fund is that the allocation doesn’t stay fixed. So maybe in year 26, or age 26, or in age 30, you’ll see within your target date fund that instead of 95% or 99% equities, maybe I now own 90% equities, as it’s taking more fixed income risk—or bond risk—and less equity risk. 

The purpose of this is to use long-term, what I would call capital market assumptions, as well as an understanding of what drives human savings behavior—what we call human capital—in terms of an investor’s working lifecycle in the retirement construct. A bit different in retirement, in education savings, in other places. 

To build an optimal strategic allocation that allows investors to take what we would deem the appropriate amount of risk wherever they are within their investing lifecycle. So again, to my point earlier—individuals who are age 20, age 25, long time horizon to retirement—can take the most amount of risk at that point. 

You don’t want age-60 individuals taking that same amount of risk, all else equal—unless they purposefully elect to do so. In that case, you are much more, call it, 50% bonds / 50% equities, or even 40% equities / 60% bonds. 

So think about the asset allocation shift as mostly strategic in nature—long-term capital markets-driven, not necessarily tactically managed, and more model-based, in the way I would describe it. 

If I buy a target date fund today, and you buy the same age vintage of a target date fund today, we get the same exposure and we’ll have the same kind of glide down the glide path, all else equal. 

Cassidy Clement: You had mentioned the details that would go into why a lot of listeners or investors look to target date funds as the conservative autopilot option. We mentioned this a little bit in the intro because it is long term and model-based. You’re setting it and watching it as it moves toward that date that you are looking to be a part of or potentially sell at. 

But what are some things to keep in mind if listeners are looking to incorporate target date funds into their financial strategy? Because really, at the end, you’re looking to get some type of a return to utilize for a goal that you desire to reach. But there’s obviously good and bad risk and reward associated with all investments. 

Rob Crothers: Totally with you, Cassidy. What I would say a target date fund is, at its heart, is a do-it-for-me investment approach, right? I buy a target date fund when I’m young. I buy a vintage, for example, or an age that corresponds to when I expect to retire—let’s just say age 65. And then it’s going to continue to take the appropriate amount of risk, in the manager’s determination, over that time up to the point of the target. 

Things to keep in mind—do-it-for-me works for some, but not all. And it doesn’t necessarily have to be all of your savings. Many folks use target date funds as a core, for example, of their savings that will do it for them, and then they invest other capital—whether it’s supplemental capital in their retirement plan or outside of their retirement plan, or other capital that they have—to invest in a different way. 

For example, it can be your entire savings if you’d want it to be, but it doesn’t necessarily need to. 

The thing that do-it-for-me creates is really two behavioral challenges. The first is a lack of an explicit need to engage with your money. So one thing I would caution all investors to do is to continue to stay engaged. That doesn’t mean checking your balance every day—it’s going to move every day with the market, etc., so on and so forth—but continue to stay engaged so you understand not just what your investments are doing, but, for example, what it might be able to deliver for you. 

Because the ultimate goal in a target date fund or retirement savings is to take and create more savers—to take savers and make them investors. And target date funds do that in a very efficient way. And then take investors and enable them to live the retirement that they want—as spenders, for lack of a better way to put it. 

I think maintaining focus on what your goals are and what your objectives are—what your risk tolerance is—are important, because target date funds are actually quite flexible. So, for example, I mentioned in a career context or a working life context, someone at age 20 has the longest life cycle or longest working life—they could take the most amount of risk. That may not be suitable for them. In their mind, they may not want to take 95% or 99% equity risk. 

And as a consequence, they can buy a fund in a target date fund series that has an earlier date, for example, than maybe the one that is prescribed for—generally intended for—those that are 20. 

So being purposeful for what your goal is and understanding what your risk tolerance might be, I think, allows you to use target date funds and the like much, much more effectively. 

The other thing I’d add is: set-it-and-forget-it, to use your words, or autopilot—also sometimes, in creating a lack of a need to engage, limits the effectiveness of continual contribution. 

Again, the investments will deliver whatever they deliver. The power of capital markets is in compounding and dollar-cost averaging. And you see this a lot in the retirement context, where every two weeks you’re putting money into your 401(k), or if you don’t have a 401(k), into your IRA. 

Think about the power of compounding—in a target date fund context—is going to be driving most of the investment return, even if it is a set-it-and-forget-it-like strategy, because you’re buying in at different times, different cycles, over the course of your time. 

So don’t let the idea of set-it-and-forget-it, or one size fits all or most, or building the best product for the most amount of people, dissuade you from either engaging with your money, understanding what your goals are, and making sure that you’re invested in the right place—or continuing to save as much as you can. 

Because the primary determiner of whether you reach your goal or not is going to be whether or not you’ve saved enough money—not whether markets have done what you want them to. 

Cassidy Clement: A lot of people look toward target date funds with the pros of the rebalancing aspect, the diversification. Easy enrollment’s another pro—especially when you’re looking at it from a retirement perspective, if you’re looking to utilize a type of retirement plan within your workplace. 

But some may say that there are elements of it—the funds being maybe too conservative—when you start to enter that area. Because it can be an information overload sometimes—there’s a lot to select from. 

But what about the fees aspect and the orientation toward finding funds that are more associated with your actual goal? Are there ways to research for better fees—less conservative or more conservative investments? 

Rob Crothers: There are, Cassidy. So I mentioned earlier that target date funds aren’t homogeneous, aren’t one size fits all—they come in different flavors. There are some that are index-based, that rely only on tracking indexes. They tend to be lower cost, and they tend to be offered by a variety of providers that traditionally might have index-based investment strategies. 

There are others that are investing in active-based strategies—tend to be a little bit higher cost—but they seek to outperform the indexes by introducing active management into the target date fund or into the underlying building block funds. 

Variety of different ways—whether it’s through third-party investment research-type work like a Morningstar, a Yahoo Finance, or actually just engaging with fund companies themselves. They’re going to, most often in that case, tell you about what they do. 

But I will say that most—or many—target date fund managers offer a variety of target date funds. We, for example, offer a handful of different series. They do it a bit differently so that they can offer choice to their clients. 

Some, for example, that want an index-based implementation—lower cost, maybe a bit more certainty of outcome—versus an active implementation that seeks the opportunity to add incremental performance, which can make that compounding effect I described earlier a bit more meaningful. 

Cassidy Clement: Yeah, those are great points. Thanks so much for joining us today, Robert. 

Rob Crothers: Happy to be here. Appreciate you having me. 

Cassidy Clement: Yeah, of course. So as always, listeners can learn more about financial topics for free at interactivebrokers.com/campus. Follow us on your favorite podcast network and feel free to leave us a rating or review. Thanks for listening, everyone.