Some celebrity artists are notorious for having eccentric contract riders, from requests for backstage buckets of spicy, fried chicken wings (no thighs!) to having a personal assistant on hand to dispose of chewing gum. These peccadilloes might make an interesting read, but many lack any concrete purpose.
But that was not the case with rock band Van Halen back in the mid-1970s through the mid-1980s. In “Decisive: How to Make Better Choices in Life and Work,” authors Chip and Dan Heath illustrate how Van Halen skillfully used a contract rider as a safety-related tripwire.
A tripwire is a technique that toggles the mind out of autopilot mode and triggers decisions; it is commonly used to prevent mistakes or to avoid overlooking an opportunity.
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Van Halen’s tripwire was Article 126, better known as the M&M clause, which required a backstage bowl of M&M candies, with a catch: absolutely no brown ones. If a concert-promotion group failed to read the entire contract, including key electrical and structural requirements, and disregarded Article 126, then the band had the right to “jump” (sorry, couldn’t resist) and cancel the entire concert with full compensation.
Do you have any “brown M&M clauses” for your workplace retirement account? What’s your quality-check process for determining whether your current investment allocation is a good fit for your own financial needs? In other words, what circumstance would cause you to stop and say, “That’s a deal-breaker for me”?
Perhaps, like many American workers, you currently invest in a target-date retirement fund, or TDF, within your workplace retirement account. Target-date funds are often featured as default options in retirement plans because they offer participants a one-stop, diversified approach to saving for their living expenses in retirement. Investment managers who run TDFs typically think of participants’ needs in the context of retirement around age 65 and long lifespans after retirement.
Target-date funds can make sense for some investors in certain situations. Here are some factors to consider when deciding whether to use a target-date retirement fund:
— What are target-date funds?
— Target-date funds are popular in employer plans.
— Target-date funds are misunderstood.
— 5 tripwires for a workplace retirement account.
— How longevity factors into TDF decisions.
What Are Target-Date Funds?
Target-date funds are professionally managed investments that offer investors a one-size-fits-all portfolio of equity, fixed-income and cash assets. The goal is to create an appropriate risk-return profile for hands-off investors through asset allocation.
As investors get closer to retirement age, a target-date fund adjusts its holdings automatically to reflect a more conservative asset allocation, such as increasing bond and decreasing stock holdings. The rate at which a target-date fund changes its asset allocation strategy to become more conservative is known as a “glide path” and is dependent on the investor’s time until retirement.
See: 7 Best Growth Funds to Buy and Hold.
Target-Date Funds Are Popular in Employer Plans
Target-date retirement funds are quite practical and, as such, have grown in popularity among plan sponsors and participants since they were first introduced by Wells Fargo and Barclays Global Investors in 1994.
Morningstar’s “Target-Date Strategy Landscape: 2023” reports that investors hold $2.82 trillion in TDF assets, up from $875 billion in 2014. The high was $3.27 trillion in 2021. The Investment Company Institute estimates that 87% of 401(k) plans now offer target-date funds as investment options to employees, and reports that younger plan participants are most likely to hold TDFs.
Target-Date Funds Are Misunderstood
Despite their popularity among employer plans, AllianceBernstein’s recent “Inside the Minds of Participants” study found that TDFs are not fully understood by many employees who use them:
— 68% of plan participants mistakenly believe target-date funds are FDIC-insured.
— 57% incorrectly believe TDFs are 100% invested in cash at retirement.
— 50% mistakenly assume TDFs guarantee that their income needs will be met during retirement.
So, the immediate takeaway from AllianceBernstein’s survey is this: If you invest in a target-date retirement fund within your employer’s plan, it’s important to know what you actually own (e.g., stocks, bonds or other investments held in the TDF) and how this particular type of fund can help you.
5 Tripwires for a Workplace Retirement Account
This is where having some tripwires for your workplace retirement account can be helpful. Again, tripwires are mental constructs that can help you establish some real-life conditions that clarify whether your current investment choice is still a good fit for your needs. If you use a TDF in your retirement account, here are five tripwires to think about:
Time frame tripwire. According to the U.S. Department of Labor, American workers have a tenure of about four years with their current employer. That is a short time frame in which to save money. TDFs are intended to help workers prepare for retirement and are built for the long run, far beyond four years, and investment values can sharply move up or down in short time periods.
Vanguard’s Target Retirement Funds “are designed to balance long-term performance outcomes against multiple risks, including longevity, market risk and inflation,” says Brian Miller, a certified financial planner and senior investment specialist for Vanguard.
Vanguard manages $1.15 trillion in TDF assets for retirement investors and incorporates long time frames in its Target Retirement Funds series. “To determine the optimal glide path for the Target Retirement Funds, Vanguard produces thousands of simulations that model retirement outcomes through age 100 and beyond,” Miller says. Vanguard assesses the trade-offs between the expected lifetime spending that can be funded from a portfolio and uncertainty about that spending due to market risk.
So, think about your own circumstances: Are you really investing in a TDF for the long run? How long do you plan to stay with your current employer? When you leave, whether it’s at age 35 or 65, will your current retirement plan allow you to keep your target-date retirement fund?
Cash-flow tripwire. Let’s say you keep your target-date retirement fund until you retire. What’s next? How will your TDF support your income needs throughout retirement? J.P. Morgan Asset Management, which manages more than $132 billion in a variety of TDF strategies, including its SmartRetirement Series, incorporates cash flow in its thinking for retirement investors. “The SmartRetirement strategies have always been built off of research on real working Americans. This means that we design our portfolios factoring in the actual salaries, savings and spending patterns of American employees,” says Dan Oldroyd, certified financial analyst and head of target date strategies for multi-asset solutions for J.P. Morgan.
The company uses employee data to help it define an income replacement target at retirement and designs its portfolios around that target. Toward the end of each year, it re-evaluates how portfolios should be adjusted, testing many different investment combinations to home in on the ones that help as many people as possible reach an appropriate income replacement target, Oldroyd says.
Vanguard’s Brian Miller says the Target Retirement Funds are designed with certain baseline assumptions that reflect the average investor in Vanguard’s client base. “For example, we assume that investors begin saving for retirement at age 25, save between approximately 9% to 12% of their salary, and intend to replace 79% of their final salary upon retiring at age 65,” he says.
Risk tripwire. Planning for retirement includes a wide variety of risks, from investment volatility and potential loss to running out of money too soon. Which risk is your highest priority — the one you’d most like to avoid in the long run? Are you comfortable with how your TDF manages this risk?
Contributions tripwire. How much have you put aside for retirement? And how much will you and your employer contribute to your retirement account in the future? Since target-date retirement funds vary in how aggressively or conservatively they invest for the long run, the key here is to see how the TDF in your retirement account fits into your overall financial plan.
Other-stuff tripwire. To what extent will you rely on other accounts and benefits (pension and Social Security income, taxable investments and bank deposits, etc.) to supplement your income needs in retirement? How does your answer to this question influence your investment thought process now?
How Longevity Factors Into TDF Decisions
“We know that people are living longer. For example, our research shows that for the average retirement-age couple today, there is approximately a 46% chance that at least one person lives to age 95,” says Oldroyd. And while TDFs can help investors address key risks such as longevity, they are not designed to automate all of the necessary steps to plan well for retirement.
That’s why the mental checks, or tripwires, are needed to help retirement investors evaluate whether TDFs fit into their overall financial plan, and how their own updates — such as periodic bumps in retirement contributions and calculations of how much might actually be needed in retirement — can instill confidence along the way.
READ: 4 Best Closed-End Funds for 2023.
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Target-Date Funds: Should You Put Retirement Saving on Autopilot? originally appeared on usnews.com
