Target-date mutual funds have received a lot of attention over the past few years, even though they have been around for more than ten years. These funds have become popular investment options in many retirement plans such as 401(k) s due to their simplicity and how they are managed. In fact, they have become the defacto investment default option in many retirement plans. In other words, if someone becomes eligible to participate in a company-sponsored retirement plan, then target-date funds become the default investment option unless the participant changes or formally choses their own investment options. One of the main attributes of these funds is their ability to automatically rebalance among a mix of stocks and bonds based on one’s age. The automatic allocation adjustments take this responsibility away from investors, which is an alluring benefit some experts see as their strong appeal.
I do not necessarily have any issues with target-date funds being included in retirement plans as well as them being the default investment option for participants because many people have a difficult time selecting investment options for their retirement plans. While some plans have few options, others have too many options, which make it difficult for participants to select the right investments. I would much rather have a participant use a target-date fund than select a very conservative bond fund or stable value fund that will not sufficiently grow their account.
The concern I have with many target-date funds is they treat every investor the same and base their allocations on mostly the age of a person, and not on their particular goals and objectives. As an advisor that’s met with hundreds of people in my career, no two investors are the same. Most target date funds are designed to have more exposure to stocks in the early going, and then have less exposure to stocks (and more exposure to bonds) in the later periods. The thought here is that many of these vehicles are set up to be more conservative when someone reaches retirement. For example many target date funds would have 60% or more exposure to bonds once someone turns age 65 or older. Yet today, with people living longer in retirement and often don’t fully retire until much older, this higher bond exposure may not be the best strategy.
The following are things to consider when thinking about using target-date mutual funds:
• If you are not the type of investor that likes to create your own mix of stock and bond funds, then using target-date funds may be preferable. But keep your expectations in check and do not think because you are using a target date fund that it will provide the growth you may need to achieve a comfortable retirement.
• Remember, just like no two investors are alike, no two target-date funds are alike. For example, funds that may have identical target dates may have completely different investment allocations so it is important to understand how a fund changes its allocation over time.
• If you determine that you have under-saved during your critical working years, then you may need to replace your current target-date fund with one that has more equity (stock) exposure to give you better growth potential.
I am concerned with these funds going more conservative as one ages because bonds may not provide the types of returns they have in the past. Therefore, investors will have to be more active with respect to the kind of target date fund they use while building their retirement nest egg. In other words, investors will need to monitor the fund’s allocations to make sure they make sense. In the end, I believe participants would be better served by creating their own investment allocation, using a retirement plans current investment options, because you can control your risk exposures and investment allocations to your own situation.
I am also worried about a possible false sense of security many investors or 401(k) participants have when using target date mutual funds, due in part to these funds being touted by so many people in the media as the end-all solution. As always, you should determine what your particular financial goals are before deciding to put all your eggs into the target fund basket. If you aren’t sure whether these funds are right for you, seek advice from a professional financial advisor. After all, investing for retirement is too important to make your decisions by following the crowd.
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