Editor’s note: Rethinking65 columnist Richard B. Freeman, a senior director and wealth advisor with Round Table Wealth Management in New York, recently wrote about how advisors can work clients’ target-date funds into their overall investment plans and create “work around” strategies to overcome these funds’ limitations. We asked him how to communicate with clients about these common funds.
Jerilyn Klein: If an advisor isn’t managing a client’s assets held in a target-date fund, would speaking with that client about these assets be considered part of comprehensive, holistic advice?
Freeman: There are a couple of points to consider here. First, it’s always a good idea if you can manage the overall asset allocation in accordance with a client’s goals and objectives. Second, coordinating a target-date fund with a “work around” strategy often means an advisor must deviate from their preferred strategies in order to accommodate the target-date fund in the overall allocation.
If an advisor is managing all the client’s money — including the target-date fund, this is OK as they are accountable for everything. However, if the advisor is not managing funds — including the target-date fund, this is not OK as the advisor would be forced to alter their preferred strategies — and be held accountable for that.
Klein: Many investors choose a target-date fund for their 401(k) or IRA because they like the set-it-and-forget-it feature. But let’s say an advisor realizes a client’s target-date fund is not helping them achieve their retirement goals. What can the advisor tell this client without making them feel like they made a mistake or took the easy way out?
Freeman: It’s always best to start with a positive: Great that they recognized that their asset allocation should “de-risk” as they get closer to retirement — and target-date funds do this automatically. Having said that, the conversation should then pivot to the limitations of target-date funds in that they are not able to adjust to current financial market risks and opportunities.
Klein: How granular should advisors get when discussing with clients why they need to help balance out the clients’ portfolios to compensate for what a target-date fund isn’t doing?
Freeman: If a client is limited to target-date funds in a 401(k), then discuss a “work around” strategy. If they chose target-date funds in an IRA, then there should be plenty of non-target-date investment options from which to choose.
Klein: Can clients shop around for better target-date funds, and how would they do this? I’m thinking particularly of pre-retirees who have a choice through their401(k) plans.
Freeman: The pre-retiree choice through their 401(k) is limited to a pre-selected list that gets more conservative as the target date approaches. One could choose a fund or funds that best reflect their view of the markets and their personal risk tolerance.
For example, someone retiring in three years would ordinarily choose a ”2025 Fund,” which reflects a somewhat conservative allocation of someone retiring in three years. If the investor wanted a more aggressive asset allocation, he or she could select a “2035 Fund,” reflecting the allocation of someone retiring further in the future.
Klein: How can an advisor evaluate whether a retired client — perhaps a participant in the Great Resignation — should continue to hold onto their 401(k) that’s invested in target-date funds or if they should roll it over into an IRA where they may have better fund options? I know that rollovers can be a tricky compliance issue for advisors.
Freeman: I think a straightforward comparison between the pros and cons of target-date funds in the client’s 401(k) from a prior employer vs. an evaluation of customizable IRA investment options — including how the advisor can improve things with management of the latter — would be the right approach.
It is important to keep in mind that there are now Department of Labor rules that took effect January 31, 2022, that can apply to many 401(k)-to-IRA and/or IRA-to-IRA transactions. It’s always best to consult your compliance department to make sure you are complying with these new rules as you advise clients in this area.
Klein: When someone is ready to take required minimum distributions, what do they need to think about with regard to target-date funds? When would it make sense to withdraw those assets first?
Freeman: Assuming that they still have target-date funds at RMD ages — and I would hope the target date is “soon” to reflect the risk profile of a 72-plus-year-old person — I would recommend withdrawing from that first, leaving more customizable investment strategies for later.