Target-Date mutual funds are often viewed as panaceas for all investment problems related to retirement. This has taken hold because many investors are looking for a simple hands-off solution and mutual fund companies are willing to oblige. However, recently some of the “glow” has begun to fade and their flaws have become better understood.

Recent research by Victor Duarte, et al suggests these funds have significant flaws that become critical as the investor ages. Their main conclusions: They’re fine for young investors as their asset allocations are about 90% in stocks, which makes sense because of the long time before any withdrawals will be required. They’re too conservative for older investors. Since older investors' needs vary more than young investors, they may be well suited for the “average” older investor but perhaps not for a particular one.

That said, a Target-Date mutual fund could still be helpful for investors who require a simple hands-off “set and forget” solution. Unfortunately, as mentioned earlier, Target-Date funds’ strategies can be flawed. To understand why, let’s review the basics.

Target-Date funds contain a mix of asset classes: equities; bonds; cash. They shift the investor’s asset mix to more “conservative” each year as the investor gets closer to his target retirement date. This means increasing the percentage of the fund’s assets in bonds.

What happens in real markets? Morningstar’s research shows Target-Date funds designed for retirement in the years between 2000 and 2010 lost an average of more than 30% from peak to trough in 2008-09. They performed better when the market dropped 34% in 2020; the average Target-Date 2020 fund dropped 10%.

A key determinant of their long-term performance is their “glide path.” This is the algorithm that governs the rate the fund becomes more conservative, and its asset allocation in retirement. Current Target-Date funds have two issues: There’s no agreement on the “correct” glide path. They don’t adequately protect investors from a market crash in the crucial period from five years before retirement to five years after. This is because Target-Date funds rarely have more that 40% in bonds during this critical period. Then after this period they fail to decrease bond holdings enough to provide adequate growth.

Thus, current glidepaths do a poor job of balancing two key retiree risks: sequence of return and longevity. The first is the risk stock returns will be negative in the five years preceding or after retirement. Then, even if the stock market does better, after five years of withdrawals there might not be enough left of the portfolio to carry the retiree through retirement. The second is the asset allocation after retirement may be too conservative to provide the growth necessary to meet retirees’ lifetime needs.

Research by Wade Pfau and Michael Kitces suggests more optimal glide paths ramp down stocks to 10%-30% at retirement and then start increasing the stock holding gradually to 50%-60%. Their research indicates this type of glide path can provide better protection against sequence of return and longevity risks.

Some investors will benefit from Target-Date funds, but they should keep their expectations realistic.

All data and forecasts are for illustrative purposes only and not an inducement to buy or sell any security. Past performance is not indicative of future results. If you have a financial issue that you would like to see discussed in this column or have other comments or questions, Robert Stepleman can be reached c/o Dow Wealth Management, 8205 Nature’s Way, Lakewood Ranch, FL 34202 or at rsstepl@tampabay.rr.com. He offers advisory services through Bolton Global Asset Management, an SEC-registered investment adviser and is associated Dow Wealth Management, LLC.

This article originally appeared on Sarasota Herald-Tribune: ROBERT STEPLEMAN: The glow is fading for Target-Date mutual funds