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Should Invest in a Target Date Fund?

Posted By timparker On 03/13/2012 @ 2:05 pm In Investing | 4 Comments

If you’re young and just starting your career, you might have a 401(k) full of funds that you may or may not have picked and because you’re spending all of your time making a name for yourself in your new job, you haven’t had the time to learn about investing for retirement. That’s certainly understandable given the competitive nature of today’s job market.

When you enrolled in your company’s 401(k) program, the administrators of the plan may have told you about target date funds or, as a result of a 2006 change in the law, they may have automatically enrolled you in one of these funds without asking.

What is a target date fund and is it the best use of your retirement funds?

How a Target Date Fund Works

On the surface, a target date fund is a great idea. Let’s assume that your projected retirement date is 2040. In your 401(k) fund offerings you might find a 2040 target date fund that allows you to “target” the date. These funds actively managed funds designed to adjust your asset allocation, (the percentage of stocks to bonds) as you get closer to retirement.

Since you’re young, this fund will likely invest nearly all of the funds in stocks. In fact, close to 90% [3]. As you approach retirement, the percentage of safer bonds will increase so you’re less exposed to the natural ups and downs of the stock market. Target date funds are a great idea for people who don’t know how to adjust their asset allocation or don’t have the time or knowledge to pick the proper stocks, index funds, or bonds to meet their goals.

The Risks

Every investment has good and bad points and that’s where risk management should be considered. We already know the positives of target date funds but there are also some negatives.

First, target date funds are actively managed. This means that somebody is getting paid a large amount of money to manage the fund. This fee is built in to the fee structure of the fund meaning that you are giving back part of your gains to the person running the fund. Those fees can be quite high especially when you add up the fees over the thirty or forty years you would hold the fund. It isn’t unreasonable to pay the person managing the fund but sometimes those fees cause the fund to lose money in a given year.

Second, some target date funds are designed to only get you to your target date [3]. Others aim for 10 to 15 years after the date so the fund continues to work for you after retirement.

Finally, the fund will be diversified but putting all of your money in to one investment product is always ill advised although many younger investors don’t know that or haven’t been educated in diversification.

How To Invest

If you think a target date fund is right for you and you’re not locked in to only one fund type through your 401(k), find a fund with a good track record and low fee structure. Vanguard is a good place to start. Other popular funds come from Fidelity and T. Rowe Price. Finally, make sure to read about the objectives of the fund. If the fund only aims for the actual target date, you could invest in a target date fund that matures 10 years before your projected retirement date.

Finally

Target date funds are perfect vehicles for young people who don’t want to worry about their asset allocations but remember that taking a hands off approach to your retirement planning is ill advised. If you’re in your 20s, you have time but as you age, you have to be the person in charge of your financial future.


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[3] close to 90%: http://www.kiplinger.com/columns/starting/archive/investing-in-a-target-date-fund.html

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