- Target Date Funds are a popular choice in retirement plans.
- Understanding the asset allocation and glide path for the fund is important.
- For some investors, risk tolerance may not fit a fund’s allocation.
In a world seemingly obsessed with automation and quick solutions, target date mutual funds have grown in popularity with investors. Their rise in popularity is due to Congress’s 2006 decision to make target dates the default option for retirement plans and as well as the fund’ “set it and forget” ease of investing. On the surface, target date funds are easy to understand, select and invest in. However, investors need to be clear about how target date funds really work, as well as the costs associated with such funds and if the fund (or funds) they’re considering truly fit their individual risk tolerance.
Target date funds fall into two categories: “To Retirement” and “Through Retirement.” The difference can be found within each fund’s “glide path” or asset allocation mixture as the investor reaches retirement age–and beyond. The picture below illustrates the difference:
As you can see in the chart above, the target date to retirement becomes increasingly conservative as the investor gets closer to their projected retirement date and maintains its allocation after retirement. Conversely, Target date through retirement funds hold a higher concentration of equities for a longer period of time than “to funds” and do so past the target retirement age.
*graph from Aon Hewitt found here
This difference, while seemingly small, is important to understand. Each investor must identify their long-term goals, as well as the age at which they’d like to retire and how long their money needs to last in retirement. Whether it’s to or through retirement, picking a fund that closely matches your long-term goals and portfolio objectives puts you in a better position to reach those goals and objectives.
Target Date Investor Behavior…Making Investment Discipline Easier
Once an investor has selected which type of target date fund fits their appetite for risk, they are often able to “set it and forget it.” The ease, simplicity and built-in discipline of target-date funds reduces the likelihood of an investor behaving irrationally during periods of high market volatility. Morningstar recently published an article highlighting the benefits of target dates with respect to investor behavior. If an investor has picked a target date that matches their risk tolerance, the set it and forget aspect of these funds reduces an investor from making the classic “sell low-buy high” mistake. Target dates inherently make investors more disciplined, which puts them in a better position to reach their goals.
Target date funds are popular investments in retirement plans. As with all investments, the key to success, is to understand how and if these funds fit into your total financial picture. Understanding the glide-path, the cost and the objective of the target date fund, combined with good investment behavior, can keep you on the correct path to retirement. If you have any questions about target date funds or options available in your retirement plan please feel free to contact us any time.
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