Target-date funds offer the same exposure to stocks and bonds whether you’re 65 or 85, which is not optimal, says Christopher Davis, strategist and director of research with Morningstar Canada.J.P. MOCZULSKI/The Globe and Mail
Congratulations, you have retired. Now you're hoping your savings and government benefits can support you for the rest of your life.
But Canadians who have invested in target-date funds might be wondering: Now what?
These investments offer a set-and-forget strategy. Basically, investors buy a diversified portfolio of funds – usually mutual funds or exchange-traded funds (ETFs) – that is rebalanced over time and becomes more conservative as retirement approaches.
These products typically make up common-core holdings in defined-contribution pension plans and workplace registered retirement savings plans (RRSPs) but are also available to retail investors. They are primarily designed to accumulate wealth.
But what happens once you retire? Can you still stick with a target-date fund?
"Target -date funds are better at helping investors get to retirement in a hands-off, easy-to-manage way, but they're not as helpful for investors in retirement," says Christopher Davis, strategist and director of research with Morningstar Canada.
This is largely because target funds are designed to build savings rather than unwind them as income in retirement.
In a nutshell, target funds work like this: Investors choose a retirement date, and an investment firm providing the product offers fund-of-funds portfolios with retirement dates in five-year increments.
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In the event your retirement date falls between those increments, you would be slotted into the closest target fund, says Jonathan Jacob, senior vice-president and head of portfolio risk solutions for Greystone Managed Investments Inc. in Toronto.
"For example, if your retirement date is 2022, your capital would go into the 2020 target-date fund," says Mr. Jacob, whose firm provides target funds to plan sponsors, who then offer them to their employees.
What each target date offering then provides is an asset mix of stocks, bonds, cash and other securities, such as real estate. "The asset mix changes over time to the target date," says Ryan Kuruliak, an investment analyst and senior vice-president with Proteus Performance Management Inc. in Toronto.
These funds generally stop morphing once an investor retires, or within five years of retirement, he says. After that they default to an income-oriented portfolio that does not change over time.
But that might not be a good fit for retirees, he adds. Retirement at age 65 can last more than 30 years, so investors might want to start with more equity exposure.
Yet most target-date options do not offer this kind of post-retirement customization, Mr. Kuruliak says.
Target funds make up a small part of the fund industry, representing less than 2 per cent of assets, according to Morningstar Canada. Moreover, the lion's share of target funds are found in workplace retirement plans, and most workers' relationships with their defined-contribution and group RRSP plans end once they retire.
"One of the challenges for individuals in this situation is they are left to their own devices, which can be dangerous if they're not well versed in investing," Mr. Kuruliak says.
In some cases retirees can stay with the same fund family, but the fees are often higher than when they were members of the plan, he says.
Moreover, the available options might not fit their retirement needs. Target-date funds can provide retirement income, but they don't help retirees figure out, for example, how much capital they might have to withdraw over and above the income generated from their investments to meet their needs in a sustainable fashion, Mr. Jacob says.
Retirees leaving workplace plans can shop for other funds, says Dan Bortolotti, a certified financial planner and associate portfolio manager with PWL Capital in Toronto.
"You do need to look at the asset mix in the retirement version of these funds because they can vary quite a bit," says Mr. Bortolotti, who also writes a popular index-investing blog called Canadian Couch Potato.
For example Vanguard Canada's Target Retirement Funds offer an allocation of 70 per cent bonds and 30 per cent equities.
"Meanwhile, the Fidelity ClearPath Income Portfolio – also designed for retirees – is closer to 75 per cent bonds, including 45 per cent in short-term bonds, so it is more conservative," he says.
And on the opposite end of the spectrum is BlackRock's LifePath Index Retirement Fund, with about 65 per cent bonds and cash, and the remainder in equities. "So it's a little more aggressive," Mr. Bortolotti says.
Another difficulty is finding advice. Because target funds are set-and-forget investments, financial advisors may avoid recommending them because clients may question why they are paying an ongoing fee for advice for a supposedly one-stop solution.
Another potential issue is target funds tend to be one-size-fits-all investments. "Target-date funds by definition are designed for the average person, and this is an issue even in the accumulation phase," Mr. Jacob says. "After all, nobody is exactly average."
For example, if an investor received an inheritance, a target fund would not automatically readjust to a more conservative asset mix now that the recipient no longer needs to aggressively build a nest egg for retirement.
Target funds also do not typically change over the course of retirement. "It's giving you the same exposure to stocks and bonds whether you're 65 or 85," Mr. Davis says. "But the risk tolerance you're going to have is very different between those two ages."
For that reason, investors may be better served with target-allocation funds, which are similar to target-date funds but allow investors to control their asset allocation over time, he says.
Mr. Jacob says retirees are looking "for the Holy Grail – investments that have low volatility, safeguard against inflation and provide income."
No one investment can fulfill this, he says, but providers of target funds are developing products that may come close, particularly as more people who have used these investments actually retire.
He thinks the fund industry will likely allow individuals to customize more, "including those that stretch all the way through retirement."