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Are Target Date Funds Off Target?

 

On Target

It seems that an easy fix for saving for retirement for many folks is to simply choose a target date fund. Generally how target date funds work is a fund company will have a set of different funds for an investor to pick from depending on a best guess estimate of when the investor wants to retire.

For example, an investor who’s 30 years old and wants to retire at age 65 may choose a 2045 fund or a 2050 fund. In this example since the investor is age 30 in the year 2014, 30 more years gets him to 2044. Most target date funds are dated in 5 year increments. If the investor was age 60 and wanting to retire at age 65, then he may choose a 2020 fund to correspond to his timeline.

Generally, the goal of target date funds is to follow a glide path that allocates the investor’s assets more conservatively as the investor approaches retirement. Then at the target retirement year, remain fixed in a more conservative allocation. The problem lies in the fact that of all the target dates funds out there, there is little conformity among glide paths – that is, different target date funds from different companies may have the same target year to retire, but may have significantly different asset allocations.

In addition, recent research has shown that target date funds’ approach in moving to more conservative assets such as bonds when investors are nearing retirement may be counterproductive. Since as an investor’s portfolio is at its largest and can therefore take advantage of compounding more efficiently, moving to conservative assets can actually hinder performance in the years right before the investor retires.

So what does an investor do? First, determine what options you have available from different target date funds. Some are better than others – especially when it comes to expenses. Next, research the fund you plan on investing in. You can also find a competent financial planner that can do the leg work for you.

Finally, determine if a target date fund is right for you. For many folks it’s a simple way to start saving for retirement in their 401(k), as well as in many company plans it’s the default option if an investor doesn’t pick a fund outright. You don’t have to have a target date fund in order to retire with a decent nest egg. There are many competent planners that can have an excellent discussion with you to determine which funds and which allocations are appropriate for you.

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2 Comments

  1. DIY InvestorNo Gravatar says:

    Good post! Target date funds are a good way to get started. For example, if someone receives $15,000 as an inheritance and has no investing experience they can easily open an account with Vanguard or Schwab for example and start with a Target Date Fund. Also, they don’t have to choose their retirement date. If the asset allocation of the fund is too aggressive or not aggressive enough for their tastes just choose a different year fund.

    1. sraskieNo Gravatar says:

      Thanks Robert! Your point is excellent as well.

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