In December 2013, the Investment Company Institute reported that 41 percent of 401(k) participants were using target retirement date funds. That’s up from only 13 percent back in 2011. Have you jumped on the bandwagon too? If so, there’s still a lot to understand even when using these purported “turn-key retirement solutions.”
But before we get into why that’s the case, let’s review the basics. A target retirement date fund is a professionally managed mutual fund that typically allocates your investment among a variety of different types of assets: stocks and bonds, foreign and domestic, cash, etc. The portfolio is rebalanced by the fund managers and becomes more conservative as the target date nears. This type of fund is designed for the investor who does not have the time, desire or expertise to manage their own diversified portfolio. The Lifecycle or "L" funds available within the Thrift Savings Plan are a good example of this type of investment.
Sounds pretty easy, right? Perhaps, but I think you’ve got to dig a little deeper to really determine if that’s true. Here are three things to remember as you evaluate your target retirement date options.
The Fund Date May Not Be Your Date
Part of the appeal of target retirement date funds is that you can ostensibly choose a fund with a date that corresponds with your own retirement date and you’re done. The reality is that stopping there might leave you with a portfolio that is much more aggressive (or conservative) than you would otherwise choose. I’ve even worked with people who I recommended choose a fund with a target date a decade or two in advance of their anticipated retirement to make sure they were investing in a way that didn’t keep them up at night. That’s why it’s important to…
Look Under the Hood
You should understand that not all target retirement funds are created equal, even if they have the same target date. I took a look at data available at www.morningstar.com and found some significant variations between different funds with the same date. For example, when I looked at a few funds with a target date of 2030, I found the stock component of the portfolios varied from a low of 43% all the way up to 76%. And exposure to foreign stocks ranged from 9% to 29%. These differences impact the bottom line for you, the investor and we haven’t even talked about expenses or sales charges which can also vary widely and should be fully understood.
There’s Still Work to Be Done
The bottom line with any fund is that it’s just an investment tool. So even if you’re using a target fund that doesn’t mean you’re off the hook for some of the heavy lifting on the road to retirement success. You still have to figure out how much you need to save to meet your goals, monitor your overall portfolio and progress towards those goals, as well as set aside money for your short-term needs so an unexpected crisis doesn’t impact your long term plans.
Unlike a lot of trends in personal finance (no emergency funds, limited retirement savings, etc.), the increasing use of target retirement date funds is one that could make sense for you. But if you're heading in that direction, dig a little deeper to make sure you’re making the most of your target retirement date fund.
As always, I encourage investors to speak with one of our financial advisors, who can help determine which investment vehicles are best suited for you based upon your individual goals, objectives, risk tolerance and time horizon.
Important note: The risks of the Target Retirement Funds reflect the risks of the underlying funds in which the Funds invest. The target date is the approximate date when investors plan to start withdrawing their money for retirement purposes. In general, the Target Retirement Funds’ investment program assumes funds will start being withdrawn for retirement purposes at age 65. The principal value of the Target Retirement Funds is not guaranteed at any time, including at the target date. The Funds’ objectives do not change over time.
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