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The Trouble with Target-Date Funds in Retirement

They may not make sense once you're past the target date.

Target-date funds, those one-stop portfolios, are good options for retirement savers who are building their nest egg. But when you quit working, you may want to take a closer look at whether your target-date fund is still the right choice for you in retirement.

These autopilot funds are hugely popular, in part because they are often the default investment choice in 401(k) plans, with your money automatically directed to them unless you elect otherwise. Half of all 401(k) plan participants had some money stashed in a target-date fund at the end of 2014, according to the Investment Company Institute.

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In a target-date fund, professional money managers make the decisions about how much of your portfolio should be devoted to stocks, bonds or other assets, and which funds to buy. Every year, the pros adjust the holdings to make the portfolio more conservative as you age. Each fund family follows its own so-called glide path for its series of target-date funds, changing the mix in stocks and bonds over time. After these funds hit their target year, some continue to adjust the stock-bond mix, typically for another 10 to 20 years, while others stop shifting entirely. This is the difference between a target-date series that shifts “through” retirement, and a series that shifts “to” retirement.

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That sounds simple and easy. But for retired investors, target-date funds may not be nimble enough. Here are four reasons it may be worthwhile to reassess your target-date fund holding when you retire.

The fund follows a “to” retirement glide path. Most target-date series follow a “through” retirement glide path. According to Morningstar, the four largest series by assets—Vanguard Target Retirement, Fidelity Freedom, T. Rowe Price Retirement and American Funds Target Date Retirement—hold 73% of all target-date fund assets. And each one takes a “through” glide path.

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But if you are invested in a series with a “to” glide path that ends at retirement, you should take a careful look at how the portfolio is split between stocks and bonds to see if it matches your need for return and your risk tolerance. In the target year of JPMorgan SmartRetirement series, for instance—the fifth-biggest target-date series—the portfolio has 38% of assets invested in stocks, which falls below the average for all target-date funds. For some investors, that may be as much risk as they want to take. Others, however, may want to invest more in stocks, especially considering that retirement might last for decades.

In fact, the general idea behind target-date series that glide “to” retirement is that you’ll sell your shares in the fund when you retire and move the money to an IRA, where you have the freedom to invest in other assets, says Todd Rosenbluth, head of mutual fund and ETF research at CFRA, an investment research firm.

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You’re a different investor today than you were in your thirties (or even your forties or fifties). After you retire, you may feel differently about risk. An investor’s tolerance for risk can change over time, especially after you leave your job, says Julie Virta, senior financial adviser with Vanguard’s Personal Adviser Services. For the first time in decades, you’re not building that nest egg of yours; you’re diminishing it. But Virta cautions investors not to be too conservative in retirement. “You’ll need some growth to maintain your spending,” she says.

A glide path that seemed reasonable when you bought the fund may be unacceptable now. The stock-bond divide varies among different series of funds throughout the glide path, but even more so in post-retirement years. According to Morningstar, the typical 2015 portfolio has 40% of assets invested in stocks, for instance. But the range for all 2015 target-date funds stretches from 15% in stocks to close to 60%. “Target-date funds are supposed to be one-size-fits-all, but no one really fits one-size-fits-all,” says Rosenbluth.

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You may benefit from a more tax-efficient withdrawal strategy. Sell high, not low, right? It can pay to be strategic about which assets you sell to meet your cash needs. But that’s not an option if you have all of your retirement money in a target-date fund, where withdrawals are made proportionately, according to the portfolio’s prescribed allocation, across all of the fund’s assets. “Even though I love target-date funds for accumulators,” says Christine Benz, director of personal finance at Morningstar, “most all-in-one funds are suboptimal when it comes to retirement withdrawals because the investor doesn’t have discretion over where those withdrawals come from.”

You want more diversity. The predominant flavor in most target-date funds is plain vanilla. Although some funds may hold preferred stocks, convertibles, futures or options on commodities, for example, most of the money in target-date portfolios is divided between stocks, bonds and cash. That presents a challenge these days. With a low return outlook for both stocks and bonds, what’s a target-date fund investor to do? A customized approach to your portfolio in retirement might offer more flexibility. You could, for instance, hold more cash or invest in alternative investments that don’t move in lockstep with stocks or bonds.

You’ll also want to consider whether you’ll have too many eggs in one fund family’s basket. Fund firms often fill their target-date funds with “the family’s greatest hits,” says Rosenbluth. It’s up to the investor to determine if those funds are appropriate for them, he says, adding, “Do you want to buy all of your clothes at one department store?

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