Target date funds use differing ways to adjust investments over time, showing that even simple money decisions have unexpected complexity.
Though I will echo the great Warren Buffett quote (when referencing how he would direct his estate to invest his money for his wife after he was gone):
My advice to the trustee could not be more simple: Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund. (I suggest Vanguard’s.)Warren Buffett
Just saying, if it’s good enough for Warren, it’s probably good enough for, you know, everyone.
But index funds, being some of the most passive type of investment there is, might actually be too active for some particular folks who wish to do nothing with their investments over time. Like nothing. Ever. For decades.
And since conventional wisdom (whether we agree with it or not) says that we should get more conservative with our investments over time, that collides with some people’s desire to do nothing.
Enter the target date fund.
I’ve talked about target date funds before. They start out aggressive, and automatically become more conservative over time as you reach retirement age.
I’m lukewarm on target date funds; they are certainly better than nothing, and for sure better than investing in specific stocks, but they might potentially be a little too conservative for what we’re probably going to need for our retirements.
But it’s simple, right? There’s nothing to say about a target date fund. You just put money in, and you don’t need to think about it.
Actually, as it turns out, target date funds aren’t as simple as you may have been led to believe.
And while the specifics aren’t so important (you can skip the details if you want), it illustrates nicely how “simple” financial solutions may not actually be so simple.
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A local financial advisory firm (one that, I should add, I don’t have any association with other than being on their mailing list), recently released a blog post and report about glide paths.
Definition from Investopedia:
Glide path refers to a formula that defines the asset allocation mix of a target-date fund…The glide path creates an asset allocation that typically becomes more conservative…as a fund gets closer to the target date.
Yes, glidepaths, that period of time in which the allocations of target date funds go from normally aggressive (in early years) to conservative (such as in retirement)
Here’s an image to show what I mean.
That diagonal part in the middle? That’s the glide path.
I confess I had never thought about glide paths. I suspect most people don’t, but according to the above-mentioned firm, to engineer a glide path require decisions to be made on many levels.
As they go on to say:
The slope describes a glidepath’s shape – how quickly or slowly the percentage of stocks in the fund changes as the fund de-risks over time…A steeper slope indicates a larger difference between the amount of stock a fund has at the beginning compared to the end. Too much slope risk could increase a participant’s exposure to equity market risk…A flatter slope may help reduce overall volatility and loss but may impact a fund’s longevity risk…
I guess this should make some intuitive sense. If you have 80% of stocks and 20% of bonds, your volatility and potential upside will be high as compared to a portfolio that is 20% stocks and 80% bonds.
But switching from the former to the latter can happen in a myriad of ways and speeds, all of which could impact your portfolio and create different kinds of risk, either locking in arbitrary gains and losses, or running out of money.
And this gets even more complex when it’s not just two options (the oversimplified “stocks” and “bonds”) but other investments as well.
Skip down here if you don’t understand
Now, you can read the post and download the whitepaper if you want, but my point is not to explain these things to you. Frankly, I’m not 100% sure that I do.
The point is that a financial product that is billed as being “simple”, “one-size-fits-all”, turns out to be anything but.
Vanguard, for example, has multiple target-date funds, but they appear to be solely (or at least primarily) based on retirement date, running through each glide path on a different schedule.
Is Vanguard’s glide path better than some other company? Who knows? I sure don’t.
I’m not saying that because these decisions can vary widely, that the benefits are overstated.
But I do think that one can be lulled into a false sense of simplicity with financial products that claim to “take care of everything”.
Not everyone is a money nerd. So it’s best to get a team together to handle the aspects of your financial life that you’re not skilled at. Like investments.
This example just shows why. Even the simplest solutions turn out to be not so simple. Make sure it’s someone you trust who will figure out your own glide paths.