A Target Date Fund (TDF) is a hybrid mutual fund that automatically adjusts the asset allocation, such as, stocks, bonds, cash equivalents, in its portfolio as it gets closer to the specified date. Typically the year corresponds closest to the investor’s retirement year.
TDFs have grown in popularity in recent years. According to BrightScope Projections, TDFs may make up one third of all 401(k) assets by 2020, totaling more than $2 trillion. More 401(k) plan managers have been offering TDFs in plans, as the Department of Labor authorized them as a Qualified Default Investment Alternative in 401(k) plans. However, just because the option exists in a 401(k) plan, does not make it a safe, low risk option for your retirement savings. Here is a list of some of the advantages and disadvantages of TDFs:
Pros:
- A TDF is an easy and efficient way to invest in a diversified portfolio.
- They are “designed” to be a set-and-forget investment, because TDFs automatically reallocate assets in a portfolio over time.
- This is supposed to reduce risk and volatility the closer one is to the target date.
- TDFs, typically, invest in more aggressive assets initially and over time.
- As the target date approaches, it should reallocate to more conservative investments.
- Hands-off investors find them appealing since they do not have to actively manage their portfolio.
- A TDF should keep an investor from being too aggressive when they are near retirement.
Cons:
- TDFs do not always invest as conservatively toward the end of the timeline as investors might think. Check the specific fund and its allocation schedule.
- TDFs have different fund managers with differing strategies and approaches to asset allocation.
- Some are invested 30% in equities the year before retirement; others can be invested as high as 70% in equities.
- Many TDFs invest in mutual funds or indices for the equity allocation portion of the fund.
- Oftentimes, the mutual funds chosen are from the same family as the TDF provider. This could be seen as a conflict of interest.
- This could be done to increase sales of underperforming or mediocre proprietary funds in order to attract assets and make them profitable.
- Fees can be high on some TDFs, largely because they invest in funds, which often adds an overlay fee.
- You may pay another layer of fees, because you pay a fee on the mutual fund the TDF invests in, as well as the fee the TDF charges.
- TDFs typically have a one-size-fits-all mentality for all investors, and typically lack different risk tolerance levels: aggressive, moderate, or conservative.
- Many times a 401(k) plan may only offer one provider of TDFs.
- If this is the case, make sure that the family of funds offered is in line with your goals and expenses are low before choosing it as your investment.
- Previously, it was difficult to compare TDFs, but Morningstar has begun rating them and has performance data available for investors’ to make comparisons.
- REMEMBER: Just because you are investing in a TDF does not mean that the fund carries low risk.
- The average fund lost 23% of its value in 2008 during the financial meltdown!
As you can see, there are many more factors to consider when selecting a target date fund than just the date you want to retire and a fund with a corresponding date. Some investors will find target date funds appealing, because they have become popular as the default investment in many 401(k) plans. However, it is essential for you to check your employer-sponsored plan to ensure that the fund fits your goals and risk tolerance level before investing. If not, there are many other investments that may suit your needs and maintain a risk level within your comfort zone. Do not forget to check the ratings of any TDF or mutual fund when considering investments. Morningstar rates several Target Date Funds, as well as most mutual funds, so there is performance data available for investors and comparisons can be made between funds.
If you have questions regarding the investment options in your employer-sponsored retirement plan, the experts at Henssler Financial will be glad to help. You may call our experts at 770-429-9166 or e-mail at experts@henssler.com.