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American Funds Target Date Retirement

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The American Funds Target Date Retirement Funds Are A Top Pick for Retirement Savings

When it comes to saving for retirement, having the right investment strategy is essential for achieving securing your financial future. It’s like having the right game plan heading into the Stanley Cup Finals. Smart decisions now pave the way for victory down the road. For my money, the American Funds Target Date Retirement Series from Capital Group is a top contender for a spot in your retirement game plan.

Like all target date funds, these funds are designed to adjust their risk level and asset allocation as you progress through different life stages. What sets them apart is their proactive approach to managing two critical risks in retirement investing: longevity risk and market volatility. Think of it as having a coaching staff that adapts your lineup and playing style to counter the opposition’s strategy at each stage of the season.

Longevity Risk – Playing the Long Game

The fear of outliving your savings looms large in retirement planning. With life expectancy on the rise, a forward-looking investment approach is essential to stretching your retirement funds further. The American Funds Target Date Retirement Series maintains a significant allocation to growth-oriented equities even as retirement approaches. This focus on growth aims to combat longevity risk head-on. In contrast, some other target date funds adopt a more conservative stance, reducing equity exposure drastically near retirement. While this may lower market risk, it increases the danger of running out of money before your time runs out.

The ’Glide Path within a Glide Path’

What sets American Funds apart is their innovative “glide path within a glide path” approach. In addition to shifting between stocks and bonds, they actively adjust the composition of equity allocations as investors near retirement. During accumulation years, the focus is on capital appreciation through growth-oriented funds. As retirement approaches, the emphasis shifts to dividend-focused “growth and income” strategies. This versatile technique balances offensive and defensive positions within the equity allocation to increase income and lower volatility. This strategy aims to address longevity risk more effectively than just shifting from stocks to bonds.

Market Risk – Defense Wins Championships

Market volatility can disrupt even the most seasoned investors. The American Funds Target Date Retirement Series addresses this by making tactical adjustments to enhance stability as retirement nears. Equity exposure shifts towards higher-income assets like dividend-paying blue-chip stocks, while fixed-income allocations prioritize capital preservation with high-quality bonds. It’s a balanced approach that capitalizes on growth opportunities while safeguarding against market downturns. It’s an approach that blends offense and defense, allowing the funds to potentially capitalize on growth opportunities when markets are favorable while also providing downside mitigation when volatility heats up.

Building Depth Through Superior Asset Allocation

A key strength of the American Funds lies in their ability to construct robust portfolios from Capital Group’s extensive lineup of mutual funds. Like assembling a championship-winning team, they have access to standout funds across various asset classes and strategies. This depth allows them to construct well-rounded portfolios loaded with quality investments at every position.

Evaluating the Track Record

Beyond the appeal of the strategy, the American Funds Target Date Retirement Series boasts a track record of performance excellence. Consistently landing in the top quartiles for performance versus peer groups, these funds have delivered superior outcomes for investors over 3, 5, and 10-year periods. And all at a cost lower than any other actively managed target date series on the market.

Is American Funds Target Date Retirement Series for You?

While your options may be limited in your employer-sponsored retirement plan, you have the freedom to choose your investments in an IRA or Roth IRA. The American Funds Target Date Retirement Series is an excellent choice for investors with a long life expectancy who are comfortable with some market risk to mitigate longevity risk. However, if market volatility is your primary concern, stay tuned for my next post, where I’ll cover an alternative that might better suit your needs.

Let’s Talk Glide Paths

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Mapping Your Journey to Retirement

When it comes to target date funds, one of the biggest decisions you’ll make is choosing the right glide path. The glide path is like a roadmap that shows how your investment mix will shift over time as you approach and enter retirement. It determines how much risk you’ll take on and what kind of returns you might see, presenting a picture of how the fund’s equity exposure changes over your lifetime.

Understanding the difference between “To” and “Through” glide paths is key. The biggest distinctions come into play in what I call the “Retirement Red Zone” – the 10 years before and after your retirement date. I illustrate with some of my favorite Target Date fund series.

The “To” Glide Path: Winding Down for Retirement

Funds like the MFS Lifetime series us a “To” glide path. These are designed to shift your asset allocation to a more conservative investment mix by swiftly reducing stock exposure by the time you reach your target retirement date. This approach aims to preserve capital and mitigate risk as you near retirement. It’s similar to a football team strategically running down the clock in the final quarter to protect their lead. The landing point – when your mix locks in – coincides with your target retirement date.

Pros:

  • Reduces risk in the ‘Retirement Red Zone’. This helps to protect your nest egg from potential market volatility and the potential of sequence of return risk.
  • A more aggressive equity allocation in the early years of the accumulation phase has the potential for higher returns when your nest egg is focused on growth.

Cons:

  • May limit returns in retirement due to a more conservative asset allocation at and after the target date.
  • The conservative equity positioning may not provide sufficient long term growth after retirement to combat inflation and longevity risk during a long retirement.

The “Through” Glide Path: Prolonging the Journey

On the flip side, a “Through” glide path extends beyond the target retirement date, recognizing that retirement is just the beginning of a new chapter. That’s like a team continuing to play aggressively even after taking the lead. Most Target Date series, including the American Funds Target Date Retirement series, use this approach and have a landing point many years after retirement.

Pros:

  • Provides continued risk management and growth potential during retirement.
  • Higher equity allocations early in your retirement years can provide the growth necessary to combat inflation and longevity risk.

Cons:

  • Potentially exposes your portfolio to higher equity risk in the ‘Retirement Red Zone” when preservation of capital may be a higher priority.
  • An aggressive equity allocation exposes your portfolio to potential large losses in a bear market late in life that could severely impact the longevity of your investments.

A Few Words About Passive Index Approach to Glide Paths

If keeping costs low is a top priority, passive index target date funds like the Schwab Target Index series or the State Street Target Retirement series offer diversified market exposure at a lower cost than active funds. While passive strategies lack don’t adjust to market conditions, they do provide consistent market tracking and broad diversification, making them suitable for many investors. However, from my perspective, it’s important to remember the adage “you get what you pay for” – active management may deliver higher net returns over the long run.

Active vs. Passive Investment Management

The age-old debate between active and passive management rages on. In my experience there are some investments where active managers can add value, while in others passive index approaches make sense. The managers running active series like American Funds Target Date Retirement series or MFS Lifetime series can dynamically adjust allocations, potentially providing higher returns but at a higher cost. Passive index series like Schwab Target Index series or the State Street Target Retirement series offer diversified market exposure at a lower cost but without the potential benefits of active management. Target Date funds are one investment area where active managers often do add value.

Choosing Your Glide Path: A Balancing Act

The ideal Glide Path for you depends on your individual circumstances, risk tolerance and retirement goals. Here are some considerations to help guide your choice:

Choose a “To” Glide Path if:

  • You are risk-averse and you want to prioritize capital preservation and stability nearing retirement.
  • You have a clear idea of your retirement income needs and have other sources of income including Social Security, pensions, or annuities.

Choose a “Through” Glide Path if:

  • You have a high risk tolerance, are comfortable with some market volatility, and expect a long retirement.
  • You prioritize growth potential alongside income generation throughout retirement.

Choosing ‘Your’ Target Date

Most of you have access to a Target Date Fund in your 401(k) or 403(b) defined contribution retirement plan. While you may not be able to choose your Glide Path in your company plan, there are a couple of tweaks you can make the personalize your experience rather than accepting the default target date closest to the year you turn 65.

First, consider your actual planned retirement age. If you plan to retire earlier or later than 65, it may be wise to choose a fund with a target date that most closely aligns with your anticipated retirement timeline. If you plan to retire at 62 or earlier select the fund with a target date 5 years earlier. On the other hand if you plan to max out Social Security and retire at age 70, then choose a fund with a target date 5 years later.

Then evaluate your risk tolerance. In a similar way to your retirement date adjustment, if you are risk-averse and would prefer a more conservative glide path than the one available to you in your retirement plan, choose a fund with a target date that is 5 years earlier than your planned retirement date. On the other hand, if you feel the glide path of the fund on your retirement plan is not aggressive enough, choose a fund with a target date that is 5 years later than your planned retirement date.

Have you got all that? After considering these factors you may decide to choose the fund that has a Target Date that is 10 years before or 10 years after you would have been assigned based on the year you will turn 65. This approach ensures that the glide path is being used in a way that is suitable for you.

Glide Paths are a Journey, Not a Destination

At the end of the day, your glide path choice should align with your investment goals, risk tolerance, and retirement income needs. It’s essential to consider factors such as your desired lifestyle in retirement, potential longevity, and the role of other income sources like Social Security and pensions.

By understanding the intricacies of “To” and “Through” glide paths, as well as the potential landing points for “Through” glide paths, you can make an informed decision that aligns with your unique circumstances and investment objectives.

Remember, a Target Date Fund is a powerful tool, but it’s just one piece of your overall retirement plan.

Target Date

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Target Date Funds Can Be Your Winning Play for a Fun-Filled Retirement

What are Target Date Funds?

A target date fund (TDF) is much like having an investing coach to help you win the retirement game. These mutual funds automatically adjust your portfolio’s asset allocation over time based on a selected target retirement date, usually age 65. As you near retirement, the fund shifts to more conservative investments to reduce your exposure to market risk. It’s a convenient “set it and forget it” strategy.

How Do Target Date Funds Work?

Picture your retirement journey as a marathon race. Target Date Funds follow a stock “glide path” over time. “To” glide paths sprint to the finish line, quickly adjusting asset allocation to a conservative retirement portfolio at the target retirement date. “Through” glide paths, on the other hand, take a steadier approach. They reduce stock allocations gradually for several years after your reach your retirement finish line. These funds are geared for you to have a longer fun-filled retirement.

Target Date Funds use different approaches to winning the retirement game, just like sports teams. Active fund managers shift assets aiming for big plays to outperform the market. Passively managed funds mirror market indexes while keeping fees low. Hybrid funds mix it up, like all-around athletes in the Olympic decathlon by aiming for a sweet spot between cost and performance.

A key benefit of Target Date Funds is built-in diversification across stocks, bonds, real estate and more. This approach acts as a shock absorber against stock market swings. Just like playing defense in sports, managing risk is essential in Target Date Funds. However, some TDFs spread risk better than others through greater diversification so it’s worth comparing asset allocations between fund families.

Target Date Funds and Your 401(k) or 403(b)

Your 401(k) plan likely offers Target Date Funds as a default option. If you don’t choose your own investments, your money automatically lands in the fund closest to the year you’ll turn 65 – your ‘default’ retirement date. While TDFs are a convenient “set it and forget it” approach for those who prefer off-field pursuits, they may not fully align with your risk tolerance and personal retirement goals.

Pros and Cons of Target Date Funds

The advantages of using Target Date Funds include simplicity, professional management, diversification, and gradual reduction in risk over time as you get closer to retirement. It’s like having a coach handling your retirement game plan. However, the drawbacks center around the one-size-fits-all approach, limited investor control, and varying fees.

Selecting a Target Date Fund

Choose a TDF that uses a style that fits your risk tolerance and aligns with your comfort zone. When selecting a TDF, weigh factors like the equity glide path details, historical performance and consistency, risk exposure and fee structure. The goal is finding the best fit target date fund for your situation at a reasonable cost. Sometimes, it pays to have a good coach.

The Bottom Line: Scoring Big for Your Financial Future

Target date funds simplify investing for retirement by automatically adjusting diversified portfolios as you get closer to retirement. TDFs deliver a strategic game plan for retirement, with the potential to score big points for your financial future. Like a seasoned athlete, TDFs adapt to changing conditions, helping you stay in the game and achieve your retirement goals. So, if you’re not up for choosing your own investments, let a Target Date Fund take you on a winning journey toward a fun-filled retirement.

For a more in-depth look at Target Date Funds click over to our Target Date Funds Page. I’ll write about some of my favorite Target Date Funds in future posts.

Inflation Protected Bonds

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Battling Inflation with Inflation Protected Bonds

Introduction: Inflation – The Retirement Nemesis

Inflation is like a sneaky thief that can chip away at your retirement savings. Just when you think you’ve secured your future, rising prices can erode your purchasing power, leaving you with less than you planned. Fortunately, there’s a defensive play in your investment playbook: inflation protected bonds, specifically Treasury Inflation-Protected Securities (TIPS). These financial instruments are designed to help you keep pace with inflation, ensuring your retirement savings maintain their value over time.

Understanding Inflation Protected Bonds

Inflation protected bonds are a type of fixed-income investment that periodically adjust their principal and interest payments based on inflation. The most well-known of these are TIPS, issued by the U.S. Treasury. Unlike traditional bonds, where the interest payments and principal are fixed, TIPS’ values are tied to the Consumer Price Index (CPI), which measures inflation. This feature ensures that the interest income received by investors keeps pace with inflation, further enhancing the inflation-hedging capabilities of these securities.

Why Inflation Protected Bonds Matter

Here’s why inflation protected bonds or TIPS are important:

  • Protection Against Inflation: The principal value of TIPS increases with inflation and decreases with deflation, ensuring that your investment keeps pace with the cost of living.
  • Stable Income: While the interest rate on TIPS is fixed, the actual interest payments vary because they are applied to the adjusted principal. This means your income from TIPS can grow in an inflationary environment.
  • Diversification: Adding TIPS to your portfolio can provide a hedge against inflation, balancing out other investments that might suffer when inflation rises.

Mutual Funds and ETFs: The Easy Way to Invest in TIPS

Investing directly in TIPS is an option, but for most retirement investors, mutual funds and ETFs that focus on inflation protected bonds offer a more accessible and diversified approach.

Benefits of TIPS Mutual Funds and ETFs

  • Diversification: These funds hold a variety of TIPS with different maturities, reducing the risk associated with any single bond.
  • Liquidity: Mutual funds and ETFs can be bought and sold easily, providing greater liquidity than holding individual bonds.

Short-Term vs. Long-Term TIPS: The Winning Strategy

Short-term TIPS typically have maturities of five years or less. These bonds are more responsive to changes in inflation, providing quicker adjustments to your investment’s principal value. Here’s why they’re beneficial:

  • Lower Interest Rate Risk: Short-term TIPS are less sensitive to interest rate changes. When interest rates rise, the prices of longer-term bonds typically fall more significantly than those of shorter-term bonds.
  • Faster Inflation Adjustment: Since short-term TIPS mature sooner, their principal is adjusted more frequently, helping you keep pace with inflation more effectively.
  • Flexibility: With shorter maturities, these bonds offer greater flexibility, allowing fund managers to reinvest in new TIPS more frequently as market conditions change.

Long-Term TIPS: More Stability but Higher Risk

Long-term TIPS have maturities extending beyond ten years. While they offer protection against long-term inflation, they come with higher interest rate risk. The longer maturity means their prices can be more volatile in response to changes in interest rates.

Adding TIPS to Your Portfolio

Incorporating TIPS into your retirement portfolio requires a strategic approach. Here’s a step-by-step guide:

  • Assess Your Risk Tolerance: Understand how much risk you’re willing to take. If you’re more conservative, you might allocate a larger portion of your fixed-income investments to TIPS.
  • Determine Your Inflation Outlook: Consider economic forecasts and your own expectations about future inflation. If you anticipate high inflation, increasing your TIPS allocation could be beneficial.
  • Choose the Right Mix: Decide between short-term and long-term TIPS based on your risk tolerance, inflation outlook, and known future liabilities, such as retirement expenses or healthcare costs. A blend of both can help match the growth of these liabilities, ensuring sufficient funds are available when needed.
  • Diversify: Don’t put all your eggs in one basket. TIPS should be part of a diversified portfolio that includes other asset classes such as stocks, traditional bonds, and alternative investments.
  • Monitor and Adjust: Keep an eye on economic conditions and your portfolio’s performance. Be prepared to adjust your TIPS allocation as needed to stay aligned with your retirement goals.

Inflation Protected Bond Investment Fund Insights

iShares 0-5 Year TIPS Bond ETF (STIP)

The iShares 0-5 Year TIPS Bond ETF (STIP) targets US Treasury Inflation-Protected Securities (TIPS) with maturities of less than five years, offering a focused approach to short-term inflation protection. This ETF provides a reliable hedge against inflation with lower interest rate risk compared to long-term TIPS.

iShares Short-Term TIPS Bond Index Fund (BAIPX)

The iShares Short-Term TIPS Bond Index Fund (BAIPX) is a mutual fund designed to provide inflation protection by investing primarily in U.S. Treasury Inflation-Protected Securities (TIPS) with maturities of less than five years. This fund provides a hedge against inflation with lower interest rate risk than longer term funds.

Schwab U.S. TIPS ETF (SCHP)

The Schwab US TIPS ETF (SCHP) offers broad exposure to US Treasury Inflation-Protected Securities (TIPS) across various maturities. This ETF provides a balanced approach to inflation protection with a low expense ratios, making it a cost-effective choice for investors.

Fidelity Inflation-Protected Bond Index Fund (FIPDX)

The Fidelity Inflation-Protected Bond Index Fund (FIPDX) is a mutual fund that aims to track the performance of a broad index of US Treasury Inflation-Protected Securities (TIPS). While it has a longer duration, it provides solid protection against long-term inflation, making it suitable for investors with a longer investment horizon.

The Bottom Line: Secure Your Retirement with TIPS

Just as a seasoned coach adjusts the game plan to counter the opponent’s strengths, you need to adapt your investment strategy to combat inflation. TIPS, particularly short-term TIPS, offer a robust defense against the eroding effects of rising prices. By incorporating TIPS into a well-diversified portfolio through mutual funds or ETFs, you can simplify your investment process while ensuring your retirement savings stay in the game, no matter how high inflation climbs. Consequently, this provides you with a good chance to enjoy a fun-filled retirement without worrying about inflation eating into your hard-earned savings.