GO
Loading...

Three reasons why I like target-date funds

Recently I have been reading a lot of articles discussing the negative aspects of target date funds which generally are the default in many retirement plans such as 401(k) and 403(b) plans. Right now there are over half a trillion dollars in these funds and I do think that the media has a tendency to treat they as the "bastard stepchild" for a variety of reasons, most of which are simply not true.

Simon Battensby | Photographer's Choice | Getty Images

First, a target-date fund is generally a "fund of funds" that is designed around a certain retirement date. Within that one fund, there are many other mutual funds that are part of the holdings. So, it will have different mutual funds as part of the holding in almost every segment of the market. This would include emerging markets, international, large, mid-size and smaller U.S. funds, and different type of fixed income. They generally automatically rebalance and get more conservative over time. They are sold as a "set it and forget it"-type fund.

Read MoreWhy GOP lite is good for Wall Street

The first criticism is that because of all the different funds that are part of the target date fund, that the fees are substantially higher, which is simply not true. Generally the fees are in line with what an average diversified portfolio would be. The main thing that drives the expenses of that fund is the size of the retirement plan that you are participating in. Larger retirement plans are generally less expensive and smaller plans are more expensive, but that is not due to the target date funds, it is simply a function that smaller plans are generally more expensive.

The second criticism is that different target date funds, with the same target year for retirement, will have all different amounts of stock allocations and they be more aggressive or conservative then what the individual may be comfortable with. The solution here is simple. You want to be more conservative, select a closer year for retirement and if you want to get more aggressive, select a farther out year for retirement — solved. Let's move on.

Read MoreS&P 2,000 isn't the top: Kenny Polcari

Part of our financial-planning business focuses on personal planning, and the other focuses on company retirement plans such as 401(k) and 403(b) plans. I have presented at thousands of employee meetings over the past 27 years and here are three reasons why I like target date funds as a core position for many people invested in company retirement plans:

1. It's simple. Most people find the stock market extremely complex and even if they do listen to a ½ hour presentation, they generally will walk out of an educational meeting more confused than when they came in. They heard words like pretax and after tax contributions, asset allocation, rebalancing, bonds, stocks….blah blah blah . I would rather have them invest in something that is reasonable for them, then pick a bunch of funds that they really do not understand, and are in no way targeted around their retirement date.

2. It takes the emotion out of the investment decisions. I have never made a decent emotional decision in my life and every one that I have done resulted in years of picking up the pieces. Very rarely do I every see anyone sell funds that have done really well and buy into funds that have not done as well. Most people make emotional decisions to buy and sell funds that ends up with us selling funds that have not done well and buying into funds that have increased in value (selling low and buying high). Target-date funds automatically rebalance, selling winners and buying into losers. In a good retirement plan, you have to understand that a "loser," as someone would call it, is not necessarily a bad fund, but rather a fund that's sector was not hot in the past year. At some point it will be the hot sector. If you always chase winners, your are buying high and exposing yourself to greater risk.

Read MoreThese 19 stocks are sizzling this summer

3. It's a more appropriate plan. Most people that invest generally do not have a disciplined strategy that gets more conservative over time, rebalances itself on a systematic basis and have a review process of what investments that choose to hold. Many of the participants we see have maybe 3-5 funds that they have selected which generally means they end up with very concentrated positions in their portfolio. This is especially true as they get closer to retirement and potentially have more money to lose. Most of the target-date funds have between 10 to 20 different money managers and funds as part of their holding. They are more diversified, and get more conservative as you get ready for retirement which is a much better plan.

So the question that people then ask me is, can I create something that is more appropriate for them than a target-date fund? Yes. I feel very comfortable with saying that. I am fortunate where I have access to tremendous tools, information and resources that most individuals do not have. This allows us to customize a portfolio around the specifics or their life and the risk they are. So it IS possible to create something better; however, most people would not have the resources (or time) to do this process. Also, as a fiduciary on most of our retirement plans, I cannot give specific investment advice to employees who participate in these plans (I really never understood that one).

Read More8 out of 10 active managers are striking out this year

Like mutual funds in general, there are good and bad target-date funds. You still have to do some due diligence and ask some questions about the fund. My point is that I like the concept of these types of plans, and in the right situation these are a great option.

Commentary by Jerry Lynch, a certified financial planner, chartered underwriter and chartered financial consultant (CFP, CLU, ChFC). He is president of JFL Total Wealth Management, a registered investment-advisory firm. Follow him on Twitter @JFLJerry.