Video: Understanding Target Date Funds

[Charles Cummings]

Thank you for joining the "Understanding Target Date Funds" webinar. My name is Charles Cummings. I'm a Senior Employee Education Consultant with PNC Retirement Solutions. Today, we want to talk about a great feature of your retirement plan:

Target Date Funds. Did you know the target funds can serve as a one-stop shop investment option for people that don't feel equipped to make investment decisions and/or don't want to build their own portfolio?

But before we get into that detail, let's take a look at the overall agenda.

In Section 1, we're going to cover what is a target date fund and explore exactly what target date funds are and touch a little bit on how they work. In Section 2, we want to delve into understanding asset allocation, what that means and how it can affect your portfolio. In Section 3, we want to really dive into how target date funds work and how to properly select the appropriate target date fund for you, and then we'll wrap up in Section 4 with a summary of important best practices that we've discussed throughout the presentation. So, with that being said, let's get started.

Today, we're going to talk about, once again, the opportunity for us to discuss target date funds. So, let's dive right in and start off with what is the target date fund? When it comes to investing your money it's all about building a portfolio that is appropriate for your age, circumstances, and your risk tolerance.

A target date fund is a combination of several mutual funds that are diversified and automatically shifts towards a more conservative mix of investments as it approaches a particular year in the future, also known as your "target date".

A target date fund investor should pick a fund with an appropriate target date based on their particular investment goals. The fund managers make all decisions about asset allocation, diversification, and rebalancing. With a target date fund, you can eliminate the guesswork that may be involved in assembling a portfolio of individual mutual funds while still benefiting from a fully diversified portfolio tailored to your investment objectives and anticipated retirement date.

There are some pretty nice benefits to this for the person that doesn't feel that they are equipped to or have the desire to build their own portfolio. For starters, an investment professional builds the portfolio of underlying mutual funds. So, by investing in that one fund, you get exposure to stocks, bonds, and other investments; in other words, a fully diversified portfolio.

Second, target date funds are designed to be long term investments for individuals with particular retirement dates in mind. So, you can invest your money in a target date fund and the rest of the management of that diversified mix of investments is taken care of for you.

The name of the fund often refers to its target date. So, it makes it easier to choose the investment option that is right for you.

Now, let's talk about what's generally anticipated as two particular types of investors: active investors and passive investors.

Active investors - one way is to what we refer to as creating your own mix, which is also known as active investing. You analyze the fund options available in your plan and use the tools and resources made available by your plan sponsor to design a customized and diversified portfolio determined by your desired asset allocation mix.

There are investment options in your plan that fit into each of the asset classes we talked about, and you utilize those tools the plan provides to help you determine your risk tolerance and appropriate asset allocation strategy.

Research the investment options, and then put together a portfolio of investments that you manage yourself.

The second type of investor is a passive investor.

A passive investor is someone that invests in a target date fund that is automatically diversified and designed for you, the investor, to invest 100% of your contribution in one fund that best matches your overall time horizon. The passive investing way, we call a pre-mixed portfolio.  Target date funds do a lot of the work for you. So, researching the investments, building a diversified portfolio, and slowly making the portfolio more conservative as we get closer to retirement.

A lot of what we've talked about, thus far, the managers of the target date fund do all of that work for you. Again, target date funds are usually referred to as a one-stop shop.

Now, we're going to talk about a few common misconceptions about how target date funds work. This is where it all begins.

Primarily, we want to talk about 57% of participants, believe target date funds are 100% invested in cash at retirement. And that's not true.

Target date funds obviously become more conservative as they get closer and closer to the target date and even while in retirement. However, they do not convert completely 100% into cash because that would cause a challenge for investors in terms of purchasing power, and as a result of inflation.

If all of the money where to be converted into cash over the long term, obviously, $10,000 today wouldn't be worth the same 10 years from now and even less 20 years from now.

So, for that reason, target date funds do not completely convert to cash. They still have a moderate allocation in both stock funds or stocks and bonds or bond funds.

The second misconception, 50% of participants believe that target date funds guarantee their income needs will be met in retirement.

That's also a big misconception because of the fact there are no guarantees when you're investing in the market. Obviously, the fund managers do the best that they can to make sure that you have adequate income when you retire, thus the reason why the target date fund still has some significant allocations in both stock funds and bond funds as you approach retirement and even during retirement.

Misconception #3 - 42% of participants believe account balances and target date funds is guaranteed to never go down, and we all understand that when you're investing in the stock market. There will be times of volatility. You will see fluctuation in your overall account balance. So therefore, we don't want to give you the impression that anything is guaranteed when it comes to investing in the market.

So we talked about some misconceptions and what target date funds are. Now, we're going to transition into getting a better understanding of what asset allocation is.

This is where it truly all begins.

There are two key factors to invest in asset allocation and diversification. Asset allocation is dividing your investment dollars among the three primary asset classes stocks, bonds, and cash equivalents, also known as money markets.

Diversification is spreading your investment dollars among investment categories within each of these asset classes. In other words, you heard the old adage don't put all of your eggs in one basket.

Asset allocation and diversification is the exact practice of that. It's spreading your money out amongst different areas of the market to reduce your risk of loss and over time.

Sometimes people get the misconception that investing is all about timing the market, choosing that one right investment option, or being an investing expert. Studies and time-tested investment strategies tell us quite the opposite, however. It's actually not about any of those things when it comes to investing in your employer's retirement plan, it's about having a diversified portfolio that is allocated appropriately for you.

Some of you may have heard the adage it's not the actual timing of the market, which is important, it's the actual time in the market that's important. Now that we've talked about investment strategies, let's break it down further and discuss the types of investments that we use in those strategies. The three most common asset classes used in company sponsored retirement plans are, once again, stocks, bonds, and cash equivalents, as you see there on the screen.

Each of these investment types have very different investment objectives, and historically, each have performed differently as market conditions have changed. Since there are only three primary asset classes, you may be wondering well, why our company doesn't offer just three different investment options within your plan. While having only three options may have made your selection process easier, it is important to remember that each of the three primary asset classes can be further divided, giving you the opportunity for greater diversification. So, let's discuss the asset classes and the unique characteristics of each.

Let's begin by looking at stocks. Companies issue, or sell, stock to the public as one method to raise capital for their ongoing business needs. When you buy a stock in a company, you become a shareholder or an investor in that company.

You would typically buy stock because you expect the company to increase in value.

Some corporations pay dividends, as well. A dividend is a portion of the company's profits paid to investors. Many stocks provide both the potential for growth through price appreciation and income from dividends.

If a company issuing stock doesn't perform well, the possibility exists that the stock will decrease in value.

Thus, the volatility that you may experience in your portfolio. Stocks have more potential for price fluctuation, or volatility, than either bonds or cash.

Therefore, stocks are regarded as the asset class with the highest level of risk. Historically, this risk has been rewarded with higher rates of return over the long term. Though, the ride can be somewhat of a bumpy one.

Many retirement plans offer what we refer to as mutual funds, rather than individual stocks. Mutual funds are a pool of money where everyone's money comes together, and fund managers invest the money in underlying investments. Utilizing mutual funds can be an effective benefit to assist in allocating and diversifying your portfolio.

By using mutual funds, we gain exposure to potentially hundreds of companies' stocks, or for a bond mutual fund, we gain exposure to many underlying bonds and etc.

And that brings me to my next asset class, which are bonds. Bonds are essentially a fancy I.O.U.

Someone is borrowing money, and they are paying that money back with interest. Bonds focused on providing investors with current income. The interest rate and life span of a bond are fixed.

This gives a bond, or in this case a bond fund, more stability than stocks but less potential for appreciation.

Bonds do not have as much price fluctuation, or volatility, as stocks, but the lower the risk also means that bonds have lower return potential. Bonds are regarded as the asset class with a medium level of risk. As individuals get older, they may want to slow down and reduce the amount of money they have allocated into stocks and increase the amount of money they have allocated towards bonds.

Doing this can provide a person's portfolio with less return potential as they get older, but also less risk. It gives them stability so that they can start to protect what they've saved over the years.

The third asset category we're going to discuss are cash equivalents. Cash equivalent investments are short term and are generally very liquid investments.

These investments will have minimal price fluctuations and will pay periodic interest income. Employer retirement plans typically offer money market funds as an equivalent or cash equivalent investment option. Cash equivalents are very low risk, but they have a very low potential for return, as well. Cash equivalent investments are a great way to provide some stability as we get closer to retirement and can be a part of a very diversified portfolio.

But it is important to understand that cash equivalent investment options will not yield high returns.

Also, even though the price well, excuse me, the risk of the price of this investment fluctuating is low. There is still inflation risk involved when you're investing in a cash equivalent.

Inflation risk is the chance that cash flows from an investment won't be worth as much in the future, because of changes in purchasing power due to inflation.

We mentioned this earlier in the presentation thus why target date funds do not convert completely 100% to cash as we mentioned during the slide and mentioned the misconceptions.

History has shown inflation is average roughly 3% to 4% over the past 35 years. However, we did experience near double digit inflation as a result of coming off of the pandemic and some of the other economic challenges we faced over the years after 2020 and the Coronavirus pandemic.

If a significant portion of your retirement money is invested in a money market fund, it is worth asking yourself if you are investing to at least outpace inflation.

Now, we're going to get into some samples of portfolios for individuals as they move through their retirement cycle, or through their career.

Okay, so now we've built the foundation. We talked about different strategies. We talked about what target date funds are. Now, let's put it into actual practice. This chart that you see here on the screen, while it might look like a jumble of examples, but we really want to delve into based on your mindset as an investor.

We have a Preservation, a Conservative, a Moderate, a Balanced, a Growth and sample Aggressive portfolio.

So, how does this affect you as an investor and where you are in your retirement cycle, or where you are on your career? And which of these may be applicable based on these examples?

Well, a preservation or a conservative portfolio could serve two purposes; either for the investor that is ultra-conservative with the understanding that the ultra-conservative portfolio potentially will yield ultra conservative returns and/or the investor that is very close to retirement and may be very close to utilizing those assets.

So, a preservation or a conservative portfolio may look like 55% cash, 15% stock, and 30% bond, as you see in that preservation example. The blue represents cash, the green represents bonds, and the orange shaded portion of these pie charts represents stocks. A conservative portfolio may look like 65% bond 35% stock with no allocation in cash at that point.

The moderate portfolio you see is 50 split. 50% stock/ 50% bond.

A more balanced portfolio may have a larger concentration in stocks 65% and then 35% in bond. As you can see, the growth portfolio is majority stock and significantly majority stock and 80% stock and 20% bond.

And an aggressive portfolio, usually, allocated towards someone that has a longer time horizon, may be just starting out in their career or someone that may not have to utilize their retirement plan savings as their primary source of income in retirement.

So therefore, they could afford to be more aggressive with that portfolio.

So, again, these are just samples, these are not PNC telling you how you should invest, but to give you a guide, if in fact, you were building your own portfolio, as opposed to utilizing one of the target date funds.

Someone building their own portfolio, again, as we referred earlier in the presentation would be considered an active investor.

This slide may look like a jumble of colors.

However, it's really a picture to help back up the point that I just made about the importance of diversification. So, let's start looking at the top left in 2008. You can see it shows the returns for various investment categories for that year.

Each color represents a different investment category, and at the top of the vertical row is the best performer for that year and at the bottom is the worst performer for that year. Going across the chart, you can see that it shows returns for investment categories from 2008 to 2023.

Ultimately this chart represents the importance of a diversified portfolio where the asset allocation, or the allocation of assets are spread amongst these categories. This is also why market timing doesn't usually work.

Why building a diversified portfolio that is allocated amongst different asset classes and amongst different investment categories and sticking with it through the ups and downs of the market is typically paramount.

There will be ups and downs and nobody can predict the future, but focusing on an asset allocation and diversification can better position you to go through the ups and downs of the market.

Let's talk about the importance of not trying to time the market a little further. Timing the market is not only difficult, trying to do so can also be very costly for investors.

The following table illustrates how missing the best days in the market over the past 20 years impacts the average annual return of an initial $10,000 investment. When I say "best" I'm defining best as the highest one-day return of the Standard & Poor's 500 Index.

So, as you can see for individual that was fully invested over that 20-year period ending in March 31st, 2023, the average rate of return was 8.2%. The growth of that initial $10,000 investment during that 20-year period if they were fully invested with an 8.2% rate of return was $48,449. If that same investor missed the 10 best days during that 20-year period, their rate of return was cut in half (4.1%) as well as the growth of their initial investment dropped more than half at $22,219.

Now, I won't read each one because you can see there on the screen, but I do want to stress the fact that once you get into missing potentially the best 40 days over that 20-year period, your average annual rate of return is in the negative at -2.5% and your initial $10,000 investment has now shrunk to just over $6,000. So, again, this slide is designed to give you an example of why it's important to spend as much time as you can in the market, as opposed to trying to time the market.

We've talked about what target date funds are. We've talked about the importance of asset allocation. Now, we want to move into Section 3 and discuss exactly how target date funds work.

With a target date fund, you can eliminate a lot of the guesswork that may be involved in assembling a portfolio of individual mutual funds while still benefiting from a fully diversified portfolio, tailored to your investment objectives and anticipated retirement date.

Additionally, once you review the target date fund's glide path, or how the fund changes its asset allocation over time, to make sure it fits your time horizon. Let's now discuss some of the reasons why target date funds are extremely popular.

We're delving a little bit more into how they work.

So, you see the four points before you on the screen. Target date funds invest in multiple mutual funds and other investment products, rather than individual stocks or bonds, providing you with that diversification, which ultimately gives you some cushion during periods of market volatility.

Target date funds are a mix of funds and are created and managed by investment professionals. So, they are professionally managed. So, even for that passive investor, they're still getting the possibility for some active management in terms of the target date fund. Target date funds and the investments are geared to the fund's target retirement date. As the retirement date nears, the fund managers automatically shift the asset allocation of the fund to a more conservative risk profile.

And lastly, investors select the fund closest to their retirement date, or when they may need access to the funds. So, in essence, how do you pick the appropriate target date fund?

You'll take the year that you were born, you'd add the age you plan to retire at to that year or the year that you may think you need access to those funds, and you'll come up with a number. You'll match that number to the number closest in your target date fund list in your company sponsor retirement plan and that's how you select the appropriate target date fund.

So, let's delve a little more deeply into why target date funds are so popular.

Some potential advantages of target date funds.

Their convenience: a target date fund eliminates the need for you to research, monitor, and select the right mix of funds for your retirement assets because it's all done for you in that one fund.

Instant diversification: with a target date fund, as we mentioned earlier, you are immediately and fully diversified in an appropriate blend of a wide range of broad asset classes, and it becomes more and more conservative as you move closer to the target date.

And as I mentioned in the previous slide, one of the benefits, they are professionally managed. You have experienced investment professionals that will set the asset allocation for the fund and monitor and reallocate the underlying mutual fund investments, as needed.

So, now we want to talk about some things to consider. So, something you may want to give consideration to is the fund line up may not match your overall investment strategy.

The fund line up may be more aggressive or more conservative than you may need or are comfortable with.

So, you want to make sure that you review the fund's glide path to make an informed decision on which target date fund is right for you. Let's discuss how to select the appropriate target date fund in more detail.

Again, you take the year in which you were born, you take the age you plan to utilize those assets, you add them together, and you'll come up with a number; that number - you match that to the target date fund that most closely associates with that number, and that's how you pick the fund.

Now, 65 is the age that most target date funds utilize as a target date. So, investing in a target date fund closest to that expected year is how you'd pick your fund. There's no requirement to do. So, you may choose a different fund that better mirrors your investment objectives and risk tolerance.

Typically, you don't want to invest in multiple target date funds as the investments line up will potentially overlap each other with different allocations.

So, if, in fact, as I mentioned earlier, if you're not utilizing your company sponsor retirement plan as your primary means of income, you could afford to be potentially more aggressive with those choices, or if your plans are to utilize those assets to pass on to your heirs or beneficiaries that have a longer time horizon, you could afford to be more aggressive with your choices.

Or, if your overall risk tolerance just doesn't match up with the target date that most suits when you plan to retire, you could choose one that's more conservative. You are not required to pick the one that's closest to your age of 65.

And third, you want to review the fun fact sheet of the different dates to see the breakdown of the asset allocation to give you more information to help you better choose which target date fund may be best suited for you.

So now we've come to the end, we're going to summarize what we've talked about. So here are some key takeaways in investing in target date funds. So again, deciding what type of investor you are, can help determine if a target date fund is right has the right approach for you and your overall investment strategy. So, we want to make sure that you understand the target date funds.

Again, key takeaways they're a one-stop shop investment option. They shift more conservative more conservatively as the target date approaches. They're automatically rebalanced for you.

And they are a fund of funds providing you with extreme diversification, investing in underlying mutual funds. So, again, when you're deciding to invest in target date funds, or if you're deciding to invest in a target date fund, you want to ask yourself the following questions.

1. Do I have the desire to select my own mix of individual funds?

You would answer, "Yes" or "No".

2. Are you comfortable deciding how much to invest in each fund in your own investment mix, if you were to pick your own funds and build your own portfolio?

3. Do you have the time to monitor your investments and make changes as you approach retirement?

If you've answered, "No" to one or more of these questions then a target date fund may be right for you.

Well, that's it, so I really appreciate it. I hope you found this information to be beneficial. For more information about the funds offered your plan, please review the Fund Fact Sheets and the Fund Prospectuses for more fund specific information.

Thank you so much for joining us today.