Are Target Date Funds a good fit for your retirement plan?
Target date funds (TDF) are investment funds that take a time horizon approach to shift a portfolio’s asset allocation to become more conservative over time as the participant moves closer to their retirement date.
Confused yet? That’s a lot of mumbo jumbo for a fairly simple concept—target date funds offer diversified equities and fixed income that gradually rebalance over time. Still too jargon-heavy? We’ll break it down.
What are target date funds?
Target date funds are geared toward investors with retirement accounts—such as an IRA or 401(k)—and are typically set up to align with a participant’s planned year of retirement. Since target date funds are designed to be somewhat of a one-stop shop, you pick the TDF closest to your “target date” of retirement, and the investments change as you get closer and closer to that date. For example, if you plan on retiring twelve years from now, in 2030, you would select a 2030 target date fund. The idea is that as you get closer to retirement, your retirement portfolio should shift from an aggressive growth model to a more conservative model, protecting your retirement nest egg.
Target date funds are popular because their diversified investment strategy is professionally managed for you via a “glide path” approach. The glide path determines where the assets in the target date series are allocated based on the investor’s target retirement dates. In general, time plays a big factor in driving investment risk and return decisions. Typically, younger investors should be more aggressive to increase the potential of growing balances quickly, while older investors are conservative so as to minimize potential loss of savings as they close in on retirement.
While the number and utilization of target date funds may be on the rise, they may not always be the best solution for participants. They are often touted as being an easy way for unsophisticated investors to create a well-diversified portfolio, but choosing one is often more complex than you might think. Some TDFs invest participants’ money up to the target date, while others actively manage these through the target date. Even among TDFs with the same “to” or “through” philosophy, the glide paths can be materially different. Additionally, since many plan participants view TDFs as a “one-and-done” type of investment plan, many choose their target date funds blindly and then promptly forget about it—always assuming the investment is doing the work for them.
Target risk approach – an alternative to target date funds
In large part, target date funds singularly rely on a target retirement date, while other options focus largely on a target risk profile. These funds have diversified investment strategies that are based on an individual’s risk tolerance. And to be fair, there can be the same differences in the perceptions of what an “aggressive” portfolio should look like. That being said, there is much less doubt as to whether an “aggressive” risk approach will be more volatile than a “conservative” approach, even across providers.
There will always be outliers that make these types of decisions difficult, but participants understand risk better than they do glide paths. A target-risk fund may be best for you if you’re looking for an easy-to-understand fund that’s tailored more toward your risk preferences.
Should you use target date funds?
Targeting anything is yesterday’s news. The truth of the matter is that the average 401(k) participant has neither the desire nor the time to understand the nuances of their 401(k) investment options. And target date funds and target risk offerings don’t even matter at all if a participant isn’t in the right one or isn’t saving appropriately. Rather than spending time and energy learning the ins and outs of target date fund investments, focus instead on crafting a retirement strategy that will allow you to enjoy the retirement you’ve always envisioned.
Ryne Lambert, MBA - Financial Services Representative Team Lead - email@example.com - 800.236.7400 Ext. 3491
Ryne is a subject matter expert on 401(k), retirement savings, investments, participant advice, personal finance education, and behavioral finance.