Target date funds are a go-to retirement investment for many 401(k) plans when an employee doesn’t elect where they’d like their funds to be allocated. Some individual investors looking for an easy way to invest according to their retirement timeline use target date funds, as well. Most people want to simplify their retirement savings as much as possible. The more you can automate your investments to align with your desired retirement date and risk tolerance, the better. Although a target date fund may look like the perfect solution to this dilemma on the surface, it’s important to do a little bit of digging before you commit.
Why Use Target Date Funds?
Target date funds can be an excellent investment vehicle for people who want a relatively diverse portfolio that’s automatically adjusted as they move toward retirement. Once you’ve done the upfront research and invested, the idea is that you can be fairly hands-off. However, as is the case with most retirement savings options, it’s wise to do some research. Not just on the front end of the investing process, but periodically throughout your journey to retirement to make sure your fund is still performing in a way that works for your unique retirement plan.
Not All Target Date Funds Are Created Equal
If you take two target date funds with the same target date, you might be surprised to find out that their portfolios aren’t very similar. In some cases, they may be vastly different. For investors, this is confusing. Shouldn’t two target date funds with the same target date have markedly similar portfolio structures?
The truth is, different fund families will take different investment approaches in their target date funds. Typically, the key differences you will find across different target date funds are:
- Percentage of equities
- Asset class representation
- Glide path ages (discussed below)
Understanding what your target date fund options are comprised of will help you get a sense for their long-term investment strategy, and whether it matches up with your own.
What’s a Glide Path?
Percentage of equities and asset classes are two things that most savvy investors know a thing or two about, but a glide path into retirement? What is that?
In short, a fund’s glide path is the age that which the allocation to equities becomes and remains more conservative as an investor enters retirement. Ideally, this balance will stay relatively consistent for the remainder of an investor’s life through a target date fund.
Not every fund family has the same glide path age. For example, as of 2016 Fidelity Freedom’s was 80, T. Rowe Price’s was 95, and Vanguard’s was 75. That’s a pretty wide range.
Knowing what glide path your fund family uses will give you a better idea of when the equity percentage will level off, and whether or not that specific target date fund’s asset allocation fits your overall financial plan.
Do Expenses Play a Factor?
Expenses should always play a factor when you’re considering a variety of mutual funds. You want to make sure that you’re weighing the quality of the investment against any fees you’re paying, or you run the risk of having your hard-earned retirement savings devoured by trading and management fees.
As a general rule of thumb, fund families who use an active management strategy will have higher fees. Low-cost index funds, or passively managed target date funds, will carry lower costs (hence the name).
Most target date funds will have relatively low fees, as they’re fairly hands-off. But that’s not always the case, and it’s important to look into what type of fees you’ll be paying and weigh them against alternate options.
Which One Is Right For You?
There are so many different target date funds available, that it can be overwhelming trying to weigh the pros and cons of each before you invest.
If you’re invested in a target-date fund through your 401(k): You may be limited to only one fund family through your 401(k), but that doesn’t mean you don’t have options to consider. For example, if you find that your fund family’s target date fund has high fees through your employer plan, you may look for a low-fee index fund for your retirement savings and work to invest outside of your workplace plan to achieve the best fees and asset allocation for your unique needs.
Finding a target date fund that has low fees, a glide path that matches your needs, and an asset allocation that fits your strategy is key. Speaking with a financial planner to ensure that your investments align with your overall retirement strategy can be a huge help both in selecting the right target date fund for you. They can also help determine a plan that encompasses withdrawals and leveraging each of your retirement savings vehicles to help you achieve the savings you need to live the retirement you want.