Broker Check

The Basics of Target Date Funds

Robert Schwartz, AIF®

Senior Retirement Consultant, Tycor

If you are a participant in your company sponsored 401(k) plan, you probably know the definition of a target date fund. If not, there is a good chance you have at least heard of a target date fund.  Target date funds are investments based on a person’s age and projected retirement date. For example, let’s assume someone is age 45 and they want to retire in another 20 years or so at age 65. Since target date funds normally are offered in five year intervals, that person would invest their money in a 2040 target date fund. A target date fund is comprised of a mix of stocks, bonds and cash equivalents. Target date funds use a strategy of “set it and forget it” because the fund automatically adjusts and rebalances by becoming more conservative - i.e. by investing less in stocks and more in bonds - as a person becomes older and moves closer to his/her retirement date.

Target date funds were first introduced in the early 1990s and have become increasingly popular over the years. Target date funds are used primarily by people who want to save and plan for retirement.   Many plan sponsors use target date funds as the default option for an employee who fails to make an investment election of their 401(k) monies.  A recent 2018 study by Fidelity Investments shows that more than half of 401(k) savers have all of their retirement assets invested in a target date fund.

Here are some of the advantages and disadvantages of target date funds:

Advantages of target date funds

  • Professional management - takes a lot of the difficult and confusing investment decisions out of your hands.
  • Diversification - allows even the smaller investor to be diversified by investing in different types of stocks as well as different types of bonds.
  • Automation - rebalances the investment mix on a regular basis and gets more conservative over time.
  • Costs - many large mutual fund companies offer low cost target date funds.

Disadvantages of target date funds

  • One size does not fit all - a correct investment mix for one individual is not necessarily a correct investment mix correct for everyone.
  • Impersonal - does not take into consideration other factors such as your personal goals, needs or your other investments.
  • Risk tolerance and age - target date funds assume the younger you are the more risk you are willing to take. This is not necessarily true. Some young people don’t want to be aggressive with their retirement money and want to have lower risk investments. The reverse can be said about some older investors.

Not all target date funds are created equal. What are some other things you should be aware of and consider before investing in a target date fund? All target date funds have a glide path. A glide path refers to the fund’s changing investment mix of stocks, bonds and cash equivalents over time. As a person’s target retirement date draws near, the fund investments glide down to a more conservative mix. Some glide paths assume retirement is the target date. This is known as a “to” glide path. Another type of glide path is a “through” glide path where the investment mix continues to adjust through the designated retirement date. You should also be aware there are two different types of investment management when it comes to target date funds. Active management and passive management. With active target date management, the fund manager(s) actively buys and sells stocks and bonds while with passive target date management the investments in the target date fund mirrors different market indexes.  Another important thing to consider before investing in a target date fund is the cost associated with the target date fund. The cost of a target date fund will vary from one mutual fund company to another. Vanguard target date funds are known to be one of the least expensive. Some of the more popular and reputable target date funds are offered by the larger mutual fund families such as Vanguard, Fidelity, American Funds and T. Rowe Price.

If you have any questions on target date funds or you would like to review your 401(k) account, talk with a Tycor professional. Call us at (610) 251-0670 today!