Target Date Funds

Given the limited choices offered by many 401(k) plans it takes more more time, energy and effort to decide how best to allocate your retirement savings inside your 401(k), 403(b) and similar type plans.

Many investors, especially 401(k) investors, have decided to take the easy way out and have chosen to invest in target date funds.

Simply stated, investing in a target date fund is the same as turning over your investment strategy to a computer program with a pre-programmed asset allocation and rebalancing strategy based on your age.

If this is you then you are not alone.

According to Investment News, target date funds will capture 63% of the 401(k) contributions by 2018. So is this a good thing or a bad thing?

First here are some important facts:

Not all target date funds are equal.

Not all target date funds invest in the same types of investments with the same percentages even though they may target the same retirement year.

Not all target date funds have the same fee structure.

Not all target date funds use the same model to adjust their asset allocation over time.

What this means is the investment results from an investment in the Vanguard 2045 Fund, the T. Rowe Price 2045 Fund and the Fidelity 2045 Fund can and will be radically different over time.

Target date funds are sold as passive investments, but are they? Their asset allocation (the percentage of assets allocated to different parts of the stock and bond market) changes every year. That sounds like active management.

Past performance is no indication of future results. This is true with most investments but especially with target date funds. The reason is the asset allocation for the 2045 target date fund in 2017 will be radically different when compared to its asset allocation in 2027.

There is no question that passive investments with clearly defined asset allocations have a place in a retiree’s investment strategy. But it should be clearly defined, it should reflect not just the age of the investor but their risk tolerance, their financial status and their retirement needs. None of these are considered by the target date fund manager.

As you can tell I am not a fan of target date funds. Unfortunately, because of their simplicity, 401(k) plans will continue to be dominated by these types of investments. What I can suggest is do your homework.

Make sure you review the asset allocation and underlying investments used by your target date fund every year. Don’t be afraid to invest a target date fund that does not target your retirement date.

Finally, don’t be afraid to make a change. As you get older,  investments inside your 401(k) plan should change.