As more companies shift from pension plans to 401(k) plans, more employees have to take on the responsibility of managing their retirement investments. Yet choosing an investment strategy with the ideal asset allocation—i.e., the mix between stocks and bonds and other investments—can be difficult for those who lack detailed knowledge about how to best manage their retirement savings.
To solve this challenge, more fund managers are offering target-date funds, which essentially manage asset allocation for investors. This type of mutual fund bases its investment strategy on an expected retirement year, typically in five-year bands (one fund for 2020, one fund for 2025, etc.), and the mix of stocks and bonds adjusts as the retirement date nears.
This adjustment, known as the glide path, typically involves shifting from stocks to bonds as the expected retirement year nears to minimize risk and help provide soon-to-be retirees with more stable income in retirement.
Target-date funds are particularly popular among younger 401(k) investors, particularly as more companies include these funds as default investment choices. Nearly two-thirds of 401(k) plan participants in their 20s hold target-date funds, compared with 45% of those in their 60s, according to a study by the Investment Company Institute (ICI) and the Employee Benefit Research Institute (EBRI). And this data, released in September 2018, measures through only the end of 2016, so these numbers have likely climbed since then.
Age Is Just a Number
While target-date funds provide a simple investment strategy and take the burden of asset allocation largely off the investor, it’s crucial to look at the details of any target-date fund you might invest in to determine if it’s the right one for you. Just because you're, say, 50 years old doesn't mean you should be investing as all other 50-year-olds do, nor does it mean that a 2035 target-date fund provides the right investment strategy for you if you plan on retiring around age 65.
For example, if you haven’t saved much over the years and want to be more aggressive in seeking a higher return, then you might want to invest in a target-date fund with an expected retirement year further off then you’re planning. That doesn’t mean you need to delay your retirement necessarily, but rather that you’re choosing a fund with an asset allocation that matches your need to earn a higher return, albeit with higher risk.
Conversely, if you’re, say, 10 years away from retirement but have a substantial nest egg already, then perhaps you’d prefer a target-date fund with an expected retirement year close to the present. That’s because this type of fund would likely be conservative. You’ll have a glide path where there will soon be, or already has been, a shift primarily to bonds, ideally giving you a more stable interest rate and reduced volatility risk.
In addition to the size of your nest egg, other factors such as your risk tolerance and expected longevity can make a difference in what the best target-date fund is for your needs. For example, if you’ve been keeping up with your savings goals but are concerned about investing too conservatively in a low-interest-rate environment, where inflation might outpace returns, then you might consider taking more risk. You could invest in a target-date fund that has a longer time horizon and a higher allocation toward stocks.
Likewise, if you have a family history of longevity, then you may want a nest egg that can last more years than average in retirement. As such, you may be better off investing in a target-date fund with a date past when you’d retire. Doing so may help you gain a high enough return so that your retirement savings will be enough to last you for several decades.
Dive Into the Details to Find the Right Investment Strategy
To find the right target-date fund for your situation, you should look at the details of target-date funds in your 401(k) plan or other retirement accounts, as they can differ based on the fund manager.
Your retirement plan administrator may provide clear fund details online when you log in to your retirement account, or you could look up the name of the fund on a site like Morningstar to get insight into what the fund invests in. You can also speak with your financial advisor for help selecting the fund considering your overall financial picture and long-term goals.
From there, you can get a better sense of whether the asset allocation aligns with your goals, or whether you’d prefer to invest in a target-date fund that differs in name from your expected retirement year.
You should also take into consideration the expense ratio of target-date funds. Because these investments often comprise a mix of index funds, costs tend to be lower than other actively managed funds in a retirement plan. However, target-date funds still tend to be more expensive than investing in index funds directly. Thus, if you’re comfortable coming up with your asset allocation and glide path—or working with an advisor who can help you in that regard—then you might be better off forgoing target-date funds.
In many cases, target-date funds make retirement investing easier. Still, to really know what’s best for you, you should meet with your financial advisor to determine what type of target-date fund, if any, aligns the most with your retirement goals.
As always, please contact us with any questions, news, or comments.