Key Points
– Age-based funds are generally good for college savings plans but not for retirement savings.
– Retirement planning is more complex than college savings due to varying retirement lengths, health conditions, and financial situations.
– A customized approach with high-quality investments may yield better results than age-based funds, especially as savings grow.
Q. Dan, we had our first child in the fall, the cutest little boy I’ve ever seen, and are setting up a 529 savings plan for college. They have “age-based” funds available. That seems easy but are we missing something? — Katie in Indialantic
A. Congratulations on the birth of your son and kudos to you, Katie, for starting to plan for college early. In general, the age-based approach is a good one for college accounts but I’m not a big fan of them for the life savings of people in or near retirement.
In an age-based fund, the percentage of the assets invested in stocks is dependent on the child’s age. The percentage in stocks will be high for a newborn like your son. As your son gets older, the percentage in stocks declines while the percentage allocated to more stable assets increases. Assuming you have the temperament for a stock heavy tilt early on, this dynamic works well with college savings plans because the time frame is well defined.
Most kids start college when they are 18. Eighteen years is an excellent time frame over which to be heavily invested in stocks. By contrast, when he is a senior in high school his time frame is short and a mismatch for a stock-heavy investment mix. As such, most age-based programs will have him completely out of stocks by the time college tuition begins.
For the savings of one in or near retirement, the age-based approach often doesn’t fit very well. It seems intuitive that as one ages, they should take less risk but there are more variables involved. All newborns have the same basic time goal for college — they need money for just a few years starting on an easily identified date. That is not the case for retirement.
Mick Jagger may still be performing in his 80s but according to research published in 2024 by the Employee Benefit Research Institute, 70% of people retire before age 65. Most of these early retirees left the workforce for reasons beyond their control like corporate downsizing, poor health or the need to care for a family member in poor health.
Life is full of twists and turns. None of us truly know how long retirement will last. Will you live to be 90, 100 or 66? There are approximately 20 million people between age 65 and 69 in America. They all have different family situations that could require financial help, different pensions (if they have one), different Social Security benefits, different types of accounts, different temperaments, different health profiles and a myriad of other differences. But an age-based approach assumes the same portfolio would apply to all of them.
One other issue I have with age-based approaches and their cousin, target date funds (common in retirement accounts), stems from how the funds are constructed. They are funds of funds, meaning the target date fund itself owns a variety of funds. This is a great way to gain broader diversification but the financial institutions running the funds typically exclusively use their own fund products and some of those component funds stink.
Too often a mutual fund company with a poor performing fund that would be more profitable for the fund company if it were drawing new deposits will stuff the weak fund in a target date fund that is getting deposits. This doesn’t matter much when savings are small but over time a better result may be attained with a more customized approach that relies on best of breed holdings.
Dan Moisand, CFP® has been featured as one of America’s top independent fee-only financial planners by at least 10 financial planning publications and practices at one of America’s most decorated independent firms. For more info, e-mail him at dan@moisandfitzgerald.com, visit moisandfitzgerald.com or call Dan at 321-253-5400 ext 101.
Originally published on FloridaToday. Read the original article here.