Wall Street wants you to believe retirement risk is “one size fits all” so it can sell a mass-market product.

But that isn’t the case. “One size fits all” is a great setup for selling pre-packaged solutions in bulk to millions of investors at once. For the actual investor who is paying attention, however, this is not a good thing. The optimal level of retirement risk is not “one size fits all” and never will be, regardless of whether you are 35 or 85 or anywhere in between.

The amount of risk you should take in the stock market depends on personal factors and specific details of your personal situation. These factors vary widely from person to person and couple to couple, with the potential for very different outcomes regardless of age.

The mass-market product Wall Street loves to sell is Target-Date Funds, or TDFs for short.

Target-Date Funds, first introduced in the 1990s, are meant to simplify the retirement planning or college planning process. You pick a year that represents the year you will begin to need access to the funds and then buy a TDF “targeted” for that date. For instance, you can now buy TDFs geared toward the year 2030, 2040, or 2050.

The TDF is then supposed to automatically adjust the stock-and-bond mix of funds within the portfolio, becoming more conservative and bond-tilted as the target year gets closer. This predetermined stock-and-bond mix, and the black box nature of it, is a big part of the problem (as we will explain shortly).

TDFs really took off in the past decade or so, rising from $158 billion worth of investor assets in 2008 to $1.1 trillion in assets by the end of 2018. This was mostly due to government legislation and passive involvement from 401(k) accounts. Prior to 2008, many employees let their 401(k)s sit in cash or otherwise failed to manage the funds at all. A key rule-change made the use of TDFs an automatic enrollment choice by default.

Are TDFs a bad deal? That depends on your perspective.

A cynical, but valid answer is that TDFs are better than nothing. For the millions of employees who otherwise would not have paid attention, having their retirement funds in a predetermined mix of stocks and bonds via a TDF, which rebalances automatically and gradually becomes more conservative over time, is a better setup than having those funds in cash earning almost nothing.

For investors willing to pay attention, however, TDFs are not a good deal at all.

This is partly because TDFs can contain surprisingly high fees and because TDFs can vary widely in their levels of exposure (how much they allocate to stocks versus bonds at various points on the way to the target date).

But the main reason TDFs are not a good deal is because retirement risk is not “one size fits all” as the concept assumes in the first place. The situation for every individual investor and every retiree couple is different.

And so, if you can’t be bothered to manage your 401(k) other than signing off on papers without reading them, a TDF will probably help more than hurt. But if you are willing to get even marginally involved, plugging in the details of your situation makes a big difference in determining your best choices.

The chief problem with TDFs is that they assume, based on age or timeframe, that all investors have the same risk profile, as reflected in the same stock-and-bond mix. This is not the case though. The risk profile for each and every investor is highly personalized regardless of age, like the measurements for a tailored suit.

Imagine two men, one who is six-foot-two with a 30-inch waist, and the other who is five-foot-seven with a 40-inch waist, trying to wear the same size dinner jacket. That would be ridiculous. The “one size fits all” nature of TDFs is just as ridiculous, even if TDFs are an improvement on going bare (having no clothes at all).

Why is retirement risk, and thus the proper asset mix for each investor, such a personal thing regardless of age? It has to do with situational factors that, like suit measurements, are different for everyone. The four big elements to think about here are:

  • Capital Base
  • Risk Tolerance
  • Retirement Goals
  • Margin for Error

Capital base is a reference to how big your retirement nest egg is. To put it simply, the larger your nest egg, the less market risk you require in order to hit your goals. If your nest egg is big enough, in fact, you could conceivably fund your retirement goals with no stock market risk at all.

In contrast, the smaller your nest egg relative to your long-run retirement goals, the more market risk you will need to intelligently take on, in order to grow your capital base over time and have a reasonable chance of funding those goals.

The present size of your capital base, in other words, determines how much future funding will be required. If you are ahead of the game, you can take less market risk. If you are behind, you will need market risk and capital appreciation to do more of the heavy lifting.

Risk tolerance is a measure of how much market risk you are personally comfortable with. For example, some investors have a strong stomach lining and can sleep well at night with significant amounts of market risk. Other investors are more conservative, requiring far less exposure to be comfortable.

If your market exposure is out of whack with your risk tolerance or funding needs, you can run into trouble in both directions. Too much exposure relative to risk tolerance could give you nausea or insomnia or cause you to bail out of your plan at the worst time. Not enough market exposure, on the other hand, means you could fall short of the capital appreciation required to meet your funding needs — which means not enough money in your golden years.

This is where the “one size fits all” notion falls apart. Imagine two married investor couples, both of them 60 years old:

  • The first 60-year-old couple has a large capital base — say $7 million they acquired from selling a small business — but a very low risk tolerance (they are highly conservative and hate risk).
  • The second 60-year-old couple has a smaller capital base — say a few hundred thousand — but a high risk tolerance (a willingness to be aggressive with above-average volatility).

These two couples are the same age, but worlds apart in risk profile terms. No “one size fits all” plan could satisfy the needs of both.

Another key factor, Retirement Goals, highlights the importance of knowing what you are aiming for.

A simple and low-key retirement with a small two-bedroom house, for example, is a far cry from funding multiple charities, putting multiple children through four-year universities, and traveling around the world. The more aggressive the goals are, the more the capital base will have to be built up, which typically requires taking on more risk.

Margin for Error considers how much flexibility the investor has in terms of pivoting to a “Plan B,” or taking a back-up approach if the first plan doesn’t work out. Once again, different investors will have very different profiles in terms of margin for error.

A couple that owns a beach vacation home, for example, might know that if their market goals fall short, they can always sell the beach house as a back-up source of funds. That “Plan B” option gives them more tolerance for risk in pursuing bigger goals and above-average stock market returns.

But another couple with serious fixed obligations — like, say, supporting an adult son or daughter with special needs — may have no margin for error whatsoever in their plans, which makes all of the calculations more conservative. Their tolerance for market volatility will be far lower.

We are only scratching the surface here, but hopefully the point is clear. There is no such thing as “one size fits all” retirement risk, because every investor profile is unique regardless of age.

Target-Date Funds are certainly a better option than outright neglect (e.g. letting a 401(k) languish in cash), but with just a little more attention, the portfolio mix can be far better adjusted to individual needs.

It’s also a reality that most investors are underfunded relative to their retirement goals. While a small percentage of investors have enough capital to retire comfortably — even if they never invest in the stock market again — many more will need to generate substantially above average market returns to fund their long-term needs.

And the long-term can be “long” indeed. As we explained in The Five Risks of Retirement, there is a non-trivial possibility of living into one’s 90s. This means taking precautions to not run out of money, which typically means growing one’s capital base through intelligent exposure to market risk.

This is where TradeStops and Ideas by TradeSmith come into play.

Once you’ve determined your optimal personal investment mix in terms of stocks versus bonds, passive versus active, and conservative versus aggressive strategies, our easy-to-use investment software can help provide the overlays, ideas, and strategies you need to pursue outsized market returns.

Whatever choices you ultimately make, know that “one size fits all” retirement products are not in your best interest — and that you can potentially do better with the help of easy-to-use investment software.


Founder, TradeSmith