Target-Date Funds Are Too Risky for Savers

One of the great financial innovations in recent decades is target date funds. These investment vehicles, which have $2.3 trillion in assets, are intended to be a sort of “set it and forget it” program for investors saving for retirement, automatically shifting one’s asset allocation from aggressive to conservative over time. This might not seem to be all that revolutionary. In the grand scheme of financial innovations, it’s actually a pretty simple idea, but studies show the vast majority of investors are terrible at allocating assets optimally on their own.

The thesis behind target date funds is that the investor outsources his or her asset allocation to a fund manager in exchange for an extra layer of fees that are typically not all that large. In doing so, the investor only has to pick one fund, taking all the brain damage out of investing and having to actively change the allocation between stocks and bonds as retirement approaches. Of course, there is the risk that the target date fund manager gets the asset allocation wrong, given generally accepted assumptions about future equity returns.