TARGET DATE MUTUAL FUND WITHDRAWAL STRATEGY ISSUES FOR THE RETIREE OR PRE-RETIREE

I would like to start off with a basic introduction to retirement-based target date and lifecycle mutual funds: Larger mutual fund companies and similar entities create these particular funds and the composition of this type of investment universally is the following:

• Layer 1: “Umbrella” Mutual Fund – Let’s use the Vanguard Target Retirement 2050 Fund that is simply just a placeholder for underlying mutual funds (Layer 2)

• Layer 2: Multiple underlying mutual funds created by same company/entity where your original investment dollar is allocated to varying percentages

• Layer 3: Hundreds/Thousands of underlying stocks, bonds, or alternative investments within all mutual funds in Layer 2

Here is a real-life example. The Vanguard Target Date 2050 Fund whose ticker symbol is VFIFX would be an example of Layer 1. Inside of the Vanguard 2050 are four mutual funds which are: Vanguard Total Stock Market Index (53.40%), Vanguard Total International Stock Index (36.06%), Vanguard Total Bond Market (6.26%), Vanguard Total International Bond Market (2.86%). All four of these funds are an example of Layer 2. Inside of each of those funds are 11,796 individual stocks and 21,911 individual bonds which is an example of Layer 3.

Let’s transition into a quick real-life application to establish potential relevance to you as the reader: Likely, the easiest strategy available in most 401(k) and likewise retirement plans involve using these funds. The commonly recommended concept is to choose the fund that “contains” the year closest to your retirement year, whether that be an educated guess or specific knowledge in your specific situation. Regardless of source, these funds typically exist in 5-year increments. Example: If Company A has a Lifecycle/Target Date funds 2025, 2030, 2035, and so on… and I expect to retire somewhere between 2041-2042, then a common recommendation would consist of choosing to invest solely in the Company A 2040 Fund.

I would argue that these types of funds have can have benefits. In the right situation and with the absence of investment knowledge and/or access to good advice, these funds can be the simplest and most effortless way to create a retirement investing decision you could feel good about. Retirement goals aren’t universal, but these funds aim to do what makes sense for a lot of people, in a general sense: being more aggressive in investment strategy earlier in a working career and gradually shifting a larger portion of the retirement account dollars to investments with historically less volatility/risk. This is completed with changes and adjustments in ‘Layer 2.’

‘Simplest’ and ‘effortless’ do not necessarily equate to best available strategy and this brings me to my main purpose in writing today’s article, being just one specific downfall in utilizing this widely-available option in many retirement plans. I am going to focus on what can happen not when you invest, but rather when you sell out and take withdrawals, most prominently in retirement, after age 59 ½.

The U.S. stock market (U.S. equity) has experienced average annual return of roughly 10% over the past 30 years, but there are, of course, ups and downs and periods of high volatility historically and expected in the future again and again. Of the many 2020 & 2025 target date funds, one 2025 fund in particular is composed of roughly 28% U.S. equity while the similar 2020 fund is composed of roughly 15% U.S. equity. The concept I previously mentioned is showing true: less allocation towards higher-volatility investments as you shift into retirement. The problem with withdrawing money in retirement in certain situations is being revealed: when you sell out and withdraw money from a lifecycle/target date fund, you get your investment dollar back from ‘Layer 1,’ right back from where that investment dollar started when you were working and investing income. When you sell out of Layer 1, everything in Layer 2 is sold evenly based on current allocation to each fund. You cannot pick only 1 or 2 funds or any possible incomplete list from Layer 2 to sell from, using recent performance and forward-looking metrics as a basis for a potentially informed decision that saves/creates wealth that you could accomplish otherwise. Being invested in the right target date fund has some pros in some situations, but selling out of these funds at any level does not allow you to take into account current market environments whatsoever. There is not intelligent withdrawal strategy available even though ‘Layer 2’ contains funds of varying strategies, objectives, performance/return characteristics, and so on, because nothing is catered to you and you get no choice.

A better strategy is available with the help of a knowledgeable advisor and a portfolio of funds of varying risks and strategies not contained in the lifecycle/target date outer layer. Whether you have 15%, 28% or a different percentage of your nest egg/retirement account(s) in the stock market, it is subjectively not smart to sell out of this bucket when the underlying market is performing poorly in the short-term. The U.S. stock market experienced 37% loss in 2008. More recently, when COVID first hit, the market was down roughly 30% in a few short months. If you are taking regular income from a fund like this in a retirement or non-retirement account, you are essentially guaranteeing the future repetition of selling out of the stock market at inopportune times as inopportune times are inevitable.

In-Service Rollovers - 59 1/2

One way to prepare for retirement, with a strategy that is customized to your specific needs and withdrawal requirements, is to have your funds transferred to your IRA or Roth IRA, before you actually retire through an in-service rollover. Investopedia says that, "an in-service rollover allows a current employee the ability to move some or all of the assets in their employer-sponsored 401(k) plan into an IRA without taking the money as a distribution but rather as a rollover." That's right! If you're over the age of 59.5 you can typically move your retirement money while stilled employed. This allows you to ensure your future distribution strategy is not ineffectively selling assets at their low point, like a Target Date Fund could do. Contact one of our Financial Advisors today to discuss your ability to do an in-service rollover.