Is The Appeal Of Retirement Income Funds Warranted?
Planning for a comfortable retirement is extremely important in a day and age where the nation’s Social Security System is severely depleted. While there are many different financial vehicles you can entrust with your retirement savings, an increasing number of investors are resorting to placing their savings into retirement income funds with the goal of generating a high and stable retirement income. And indeed, these high yield income funds have proven to be a major step forward towards making investing more accessible to the masses. But while most investors in such funds are looking for super safe investment vehicle that will allow them to enjoy their day to day lives without anxiety and worry of what the future may hold, that’s not what they get. Target retirement income funds are good, but they aren’t quite the worry- and effort-free investment vehicle they are marketed as being.
Retirement income funds are currently offered by many different fund companies, including most of the largest such as Fidelity, T Rowe Price, and Vanguard. While each of these companies have different strategies, minimums and operating expenses, the overall premise of each are the same. However, choosing the best income funds to invest your money in can be a strenuous and difficult decision if you are not properly educated on the ins and outs of a retirement income fund.
Vanguard’s version of retirement income mutual funds, for example, contain low-cost index-fund-based portfolios. Vanguard has the lowest fees in the industry and has become a popular choice amongst investors (including the author). They are also relatively conservative, with the terminus Vanguard Target Retirement Income Fund (VTOVX) holding only 30% of its assets in equities, with a healthy dose of Inflation-Protected Securities thrown in for good measure. But there are two caveats here: 1.) even with its conservative 30% equity allocation, the fund still lost over 15% in 2008 and 2.) its healthy allocation to TIPS, which a strong hedge against inflation, will tend to keep its dividend yield somewhat lower than its peers. Still, this fund would be my choice of the bunch.
To illustrate the problem with these target retirement income funds, however, I’ll bring your attention to T Rowe Price, one of the most-recognized names in the retail mutual fund industry. The T Rowe Price Retirement Income Fund (TRRIX) holds approximately 40% of its assets in stocks, a risky allocation for somebody expecting a stable income and minimal volatility. I’m going to go out on a limb and say this amount of risk is down-right inappropriate for many investors. Then again, it’s perfectly appropriate for many others. The problem is, these funds are for people who don’t know much about finance and don’t care to learn. So how would they know whether the allocation was appropriate or not to begin with? They wouldn’t. They would just see “retirement income” in the name and assume it was a conservative option.
The takeaway from all this is that no financial investment is ever guaranteed and fancy pre-packed “professionally managed” portfolios don’t mitigate the need to educate yourself on the options available to you and compare all the various target retirement income funds and their relative costs and performance.
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Nice breakdown with great points!
As a big fan of the Target Retirement “idea”, I don’t think you can blame the way the funds are constructed. The problem seems to lie on how they were promoted and marketed.
Investors should define their risk tolerance, decide what the standard stock/investment breakdown is, then pick the corresponding Target fund that matches, NOT say they would like to retire in 2035 and simply select the Target 2035 fund.
With that said, I like the competition the fund giant are going through as well. You have Fidelity packing their target funds with junk and a high ER an then you have Vanguard throwing in their low cost index funds with a paltry ER. For the average Joe to have access to professionally managed, low cost portfolio in an all-in-one solution is great!
It ALL starts with educated investors and financial professionals.
One problem: the type of people who are drawn to target retirement funds aren’t interested in educating themselves. They don’t like finance, don’t care about finance, and refuse to learn about finance. Hence, they will never be educated investors and will continue to be fooled by these products. That’s the main problem I see.
I hear ya Kyle, however “those” people could do a lot worse than landing inside a professionally managed, .20% ER mutual fund. For the sake of argument, lets agree these people don’t want to be educated on the products etc., what would be a solution?
There are a ton of morons out there that’s for sure and if they can’t help themselves, I am not sure anything will help.