Target Date Funds: Retirement Timing Is Everything

Even if you do everything right, a secure retirement is not guaranteed.

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For an individual planning to retire, the 15-year period leading up to retirement has the biggest impact on financial security. Stock returns have varied from negative numbers in 1920 and 1980 to annual returns in excess of 12 percent for 15-year periods ending in the mid-1930s, the 1960s, and the 1990s, according to a recent paper from the Center for Retirement Research at Boston College.

The calculations were made using a hypothetical person—let's call him Joe Retirement Saver—who did everything that retirement experts say you should do to prepare for retirement:

  • He entered the workforce at age 22
  • Worked for 40 years
  • Put 6 percent of his income into a retirement account
  • Chose a target date fund that grew more conservative over time. When he was 25, 90 percent of the fund was in equities, gradually declining to about 45 percent by age 65.
  • Got 2 percent raises every year
  • Retired at age 62
  • Annuitized his wealth at retirement to get income for life
  • But even after Joe did everything correctly to prepare for retirement throughout his career—something few actual people are able to do—his retirement security was largely dependent on the state of the market. The amount of income he was able to replace in retirement varied by as much as 32 percentage points based on stock market performance and interest rates, the Boston College researchers calculated. "The defined contribution approach for the provision of retirement income produces dramatically different levels of retirement income depending on the performance of the markets," wrote Alicia Munnell, Anthony Webb, and Alex Golub-Sass, the authors of the paper. "This story is true even when the participants invest in target date funds that reduce their exposure to equity markets as they approach retirement."

    Over the past century, the average inflation-adjusted stock market return was 7.5 percent for stocks and 2.6 percent for bonds. But the results were highly variable, with the standard deviation being as much as 19 percent for stocks and 8.4 percent for bonds.

    If Joe, our idealized retirement saver, had retired during the 1960s or in the year 2000, he would be flying high, having built up assets equal to nine and eight times his final earnings, respectively. Whereas if he had been unfortunate enough to retire in the 1980s, he would have less than four times his final salary to finance his golden years. If Joe were to retire this year, he would have assets equal to about six times his earnings.