Target Date Funds: One Size Does Not Fit All
If you’re in an employer-sponsored retirement plan, you’ve probably heard of a target date fund. These are mutual funds that are designed to rebalance according to your age and/or time to retirement. These funds can be owned outside of retirement plans, but are generally designed for 401(k)s, 403(b)s, and others similar plans.
A target date fund’s objective is to manage risk exposure as you get closer to retirement. When you’re younger more of your money is allocated to growth investments like stocks. Then as you get closer to retirement, the allocation is less toward stocks and more toward bonds and cash, thus becoming more conservative.
I have written about these investments before and pointed out that one size does not fit all and, more importantly, that all target date funds are not created equal. Like any investment, you should do a little research and educate yourself on this type of investment before diving in.
When evaluating a fund, the first thing to look into is performance over a long period of time. Then you should check into the past performance of the fund, though realize that this is no guarantee of future results. You should always look at several funds to compare historical results.
Another characteristic of these funds to look at is how the fund is handling portfolio risk over time, which is based on how the fund manager has it set up. If a fund moves toward a more conservative allocation too soon, it could miss a market upturn and some significant portfolio returns with it. If it allocates too slowly and a market downturn occurs, your investment(s) could suffer an untimely setback. This process of shifting the allocation over time is commonly referred to as the glide path and you determine your path by what target date you choose. Depending on your risk tolerance, you could choose a fund with a date that is further out than your chronological retirement date.
This can be a key decision, especially if you don’t need to draw on the money at your normal retirement age. There are also funds that manage beyond or through retirement. In any case, you will want to maintain some growth assets to offset inflation and the potential of outliving your nest egg.
As with any investment, costs matter but I encourage you not to eliminate a choice based on costs alone. Sometimes investment returns can overcome costs, but you need to do your homework to decide this. Most of the target date funds are what we call ‘fund of funds’. This means that they’re made up of several other mutual funds and combined to make up the portfolio. This can impact costs, especially inside a retirement plan.
Target date funds are tools for your investment planning. Like any investment, you should evaluate them in light of your specific situation and should always talk with a knowledgeable advisor who not only can help you make the right choices, but also manage the funds in a way that are in your best interests.