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August 10, 2022

Optimize retirement savings with target date funds

In episode 16 of the Financial Checkup, BlackRock – the world’s largest asset manager and investment partner for the Advantages Retirement Plan™ – explains what target date funds are and how they can help you automatically grow your savings over time while keeping fees low.



Farzan Qureshi: What the real empirical evidence has shown is that those individual participants creating their own portfolios have underperformed professionally-managed target date fund investors by about 2% over a long period of time. That can add up to hundreds of thousands of dollars when you think about the compounding effect over 20, 30 odd investment years.

Speaker 2: Welcome to The Financial Checkup, a podcast series devoted to improving the financial health and retirement readiness of physicians and their spouses or common law partners. This series is brought to you by the award-winning Advantages Retirement Plan from OMA Insurance.

Alex Mazer: My name is Alex Mazer, I'm the co-founder and co-CEO of Common Wealth.

Farzan Qureshi: Hi, my name is Farzan Qureshi. I'm a director, retirement strategist at BlackRock in Toronto.

Speaker 2: This series is for educational purposes and should not be considered investment, tax, financial, or other professional advice. The views or opinions expressed by the presenters are solely their own and do not necessarily represent the views or opinions of BlackRock, the OMA, OMA Insurance, or the Advantages Retirement Plan.

Alex Mazer: Farzan, could you talk about, just at a very basic level for somebody encountering the idea for the first time, what is a target date fund and why did BlackRock invent the target date fund in the first place?

Farzan Qureshi: Great question, and target date funds are today the gold standard in terms of defined contribution or individual plan participant investing. They have really come into the fore because they're automated, they're automatic, they are professionally-managed, they're highly diversified, and they rebalance automatically over time, meaning they're age-appropriate, they're taking the appropriate amount of risk for each given age, and they're becoming more conservative over time, meaning getting the right amount of risk level for those participants who are getting older. And so it happens automatically, it happens within the fund, it's professionally-managed, and it's managed by those professionals who've done the work in understanding that trade-off between how much risk and how much age you have.

Now, they have come into the fore. BlackRock invented these types of funds in the early '90s. And in the previous experience was give investors and participants all the choices that they have, give them a Japanese tech fund, give them a US tech fund, give them a US healthcare fund, and give them 1,500 funds or as many funds and let them make their choices. And what we've noticed and what the real empirical evidence has shown is that those individual participants creating their own portfolios have underperformed professionally-managed target date fund investors by about 2% over a long period of time. When you add up that 2% of shortfall that those individual participants have had versus professionally-managed target date funds, that can add up to hundreds of thousands of dollars when you think about the compounding effect over 20, 30 odd investment years.

One of the other things that empirically has been noted is that investors maybe lack one of the three elements that makes a successful investor: knowledge, interest, and time. They may have the knowledge to invest, but do they have the interest and the time and the discipline to be in their portfolios, rebalance those portfolios every single quarter, make them more conservative, and rebalance them appropriately at the given age? Those are all really tricky and challenging things for individual participants. Professionally-managed target date funds have a huge menu of asset classes that they can choose from, and then professionally design that portfolio and make it rebalance automatically over time.

Alex Mazer: You mentioned the academic research, and there's research from both Canada and the US that shows that participants in target date funds tend to experience significantly higher returns. Why do you think that is?

Farzan Qureshi: Yeah. I think it comes back down to that knowledge, interest and time, the fact that the individual participants on their own are lacking one of those three dimensions. They may have the knowledge again, but they may not have the interest and the time and the discipline to go in every single quarter, manage that portfolio, rebalance it, make sure that it hasn't drifted. Obviously, if you leave a portfolio the day one, it starts drifting. Depending on how much Canadian equities, US equities you have, it all moves in different directions. You need to go and meticulously and disciplinedly go and rebalance that portfolio, so you have that appropriate stock bond mix at the appropriate age level.

We think young investors need to have more equities. And then as you get to retirement, you're reducing your equity systematically all the way through adding fixed income, adding those inflation hedging asset classes that we talked about. It's really that dynamic overall asset mix. How do I as an individual know what my appropriate risk level should be? That's what the professional asset managers have been doing for a really long time, and they can really build those portfolios a lot more efficiently and be a lot more disciplined around it versus individual investors.

Alex Mazer: One thing that we've seen just building on that is, and we're really pleased about this with our own plan members, is they are getting significant exposure to stocks at a young age when they have that long time horizon. Whereas if they're investing on their own or in a typical balanced fund, for example, they may not be taking enough risk that way because they've got a long time horizon. That will be one thing. The other thing that we're really pleased about is people are not getting out of the market even during ups and downs through COVID, through this last period. People tend to be staying the course when they're invested in a target date fund, which is a really positive behavior that we see and that we see across the evidence as well, as opposed to people trying to time the market by coming in and out. I don't know if that's been your experience as well.

Farzan Qureshi: I think that's been our experience as well. The target date fund managers and the target date fund investors tend to be set and forget, buy and hold. The old buy and hold, buy and hold, keep investing, keep investing periodically on your monthly, weekly, biweekly paychecks, and you just buy and hold that portfolio. You've picked it because you've got a target date in mind, 30, 40, 20 odd years in the future. You pick that date and the target date fund automatically rebalances and makes sure it's appropriate at that given time period. Whereas individual investors, you're your own CIO, you have to make those allocation decisions, you have to make those rebalancing decisions, and you have to make the asset decisions. As you said, how much equities or how much stock exposure should I have?

The target date funds tend to have 100% stock exposure early on for participants, which is what you need to have because you've got that long time horizon. But individuals tend to either overrisk or underrisk themselves. And as you've noted, they don't tend to change those risk profiles. They tend to be all aggressive too much all the way through, 100% equities all the way through, or not enough equities all the way through, and both those decisions are like driving on the 401 at 40 kilometers an hour or driving on the 401 at 160 kilometers an hour. It's just not the way to go. You need to have a balanced approach in terms of how to drive on the highway at the right time at the right speed, and that's what the target date fund is doing.

Alex Mazer: What we say a lot of times too is that success in retirement saving investing is not about doing something brilliant or doing something that no one else is doing. It's about avoiding common mistakes and just doing sensible things over long periods of time. And in a way, in a nutshell, what you're saying is target date funds are really designed to help people avoid those mistakes and mitigate the common risks associated with investing for retirement.

Farzan Qureshi: That's exactly it. Individuals tend to make all those types of common mistakes, underallocating to risk, overallocating to risk, not rebalancing appropriately, not having the right mix of stocks. You may just have all US stocks and you're missing Canadian international emerging markets. You may be missing all sorts of different asset classes. And that's where a professionally-managed fund will come in. The professionally-managed fund will look at all the other asset classes, including bonds, including alternatives like real estate, infrastructure and other things to incorporate in that total portfolio. So it's about getting the right asset mix, getting the right assets, and being appropriately allocated with that asset mix and those assets all the way through your lifetime, which is a really, really tall task for individuals to do, but much more easy for professionals to manage in a simple format.

Alex Mazer: Well, thank you very much, Farzan. We really appreciate you taking the time to share your insights behind target date funds and why they were created.

Farzan Qureshi: Thank you for having me. Thank you to Common Wealth for being such a great partner to BlackRock. Thank you.

Speaker 2: The Financial Checkup Series is produced in collaboration with OMA Insurance and Common Wealth, the administration and technology partner for the Advantages Retirement Plan.