The Pros and Cons of Target Date Retirement Funds
Last updated September 9, 2009
A new investment vehicle has emerged within the last decade, designed to help investors make sense of the jumble of funds offered by their retirement plans. These new choices are known as target date funds (TDF), and chances are your 401(k) or 403(b) plan contains at least one of these unique investment vehicles. Target date funds are typically named for the year you plan to retire, i.e. Target Date 2020, Target Date 2030 and so on.
Set It and Forget It
The idea is that these funds will change their mix of stocks and bonds as time goes on, helping younger investors capture more of the stock market's historically high returns while shielding older workers from a potentially catastrophic bear market. The actual track record of these funds has been somewhat of a hit or miss affair, so it is important for workers to research the funds they are offered thoroughly before investing.
Good Choice for Hands Off Investors
Some workers love nothing more than tracking their investments on a daily basis, while others would rather have a root canal than read the financial section of the newspaper. . If you fall into the latter category it may make sense to invest at least some of your retirement money in a target date fund. The managers of these funds make all the investment decisions for you, from the proper mix of stocks and bonds for your age to which stocks and bonds to buy.
Problems with the One-Size-Fits-All Approach
One of the potential downsides of these target date retirement funds is that they by necessity take a one size fits all approach to investing. In order to do their job the fund managers who oversee these mutual funds need to assume that every 40 year old has the same needs, and that every 60 year old pre-retiree will need the same type of portfolio. The problem is that the reality is rarely that simple - every investor will have different needs and a different tolerance for risk. Investors who dislike the cookie cutter approach to planning for retirement may be more comfortable investing on their own.
In addition, some target date retirement funds charge fees that are higher than the industry average, so it is important for workers to read the fund prospectus carefully before making a commitment. High fees can easily eat into investment returns - especially over the 20 or 30 years that these funds may be invested. Target date retirement funds can be a good choice for some investors, but it is still important for every investor to due plenty of homework.
Large Losses Occurred in the Recent Market
In the recent bear market, TDFs designed for people who have already retired or expect to by next year - portfolios that you would normally want to be relatively low risk - have lost on average a quarter of their value over the last 12 months, according to fund tracker Morningstar Inc. Two funds lost more than 30% and one skidded more than 40%, even after counting dividends paid.
The target-date struggles show the need to carefully assess a fund's holdings and investment philosophy to determine how they mesh with your financial circumstances and overall portfolio.
Your 401K May Already Include These Funds
Almost 80 percent of large U.S. plan sponsors offered target funds as an investment option through their 401(k) plans in 2007, up from 60 percent in 2006, according to research by consulting firm Greenwich Associates.
Which Funds Should I Choose?
On September 9, 2009, Morningstar launched ratings and in-depth research reports for 20 of the largest target-date mutual fund series. You can read this Target Funds Ratings report. Morningstar touts itself as "a leading provider of independent investment research in North America, Europe, Australia, and Asia".
For more information, you can talk to your investment plan advisor to see what programs your investment plan offers and see if these funds are a good option for you.
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