How do target date funds compare to other investment choices?
It can be common and easy to put your financial planning and retirement investing behind your day-to-day activities. However, it is important not to overlook where you are investing your monthly retirement contributions. Many investors use retirement date funds because this is a ‘default’ investment for their plan. In many instances, this may not be optimal and can have a negative impact on your longer-term retirement account performance. We were recently quoted in an article in NASDAQ.com discussing some of the advantages and disadvantages of using target date funds for investments. We outline some of our thoughts below.
We were recently quoted in an article in NASDAQ.com discussing some of the advantages and disadvantages of using target date funds for investments. Click here for the article https://www.nasdaq.com/articles/should-you-keep-your-entire-401k-in-a-target-date-fund.
The nice thing about investing your money in a target-date fund is that you really don’t have to do anything. Once you’ve opted for a target-date fund investment, a fund manager takes it from there and optimizes your investments based on the retirement date you give them. These funds can be used in all types of accounts, including retirement accounts and individual or joint accounts. This strategy of investing in the target-date fund might seem sound, but is it really the best place to invest your money.
Investment Flexibility
Target Date Funds don’t allow you to separate different categories of investments (value stocks, growth stocks, bonds, etc). So in essence, you can’t withdraw from investments that are doing well in certain years and avoid withdrawing from investments that are doing poorly in those same years. So the concept of ‘selling high’ can’t be met (as all your investments are in one large fund) and this can be a disadvantage of target date funds.
When you hit a certain age, you will have to take required minimum distributions and be forced to withdraw money whether you need it or not. When this happens being able to have more flexibility with what you want to sell and what you want to hold can prove to be a large advantage.
Investment Performance
In addition, since target date funds often aggregate a lot of categories of investments together, they can include a larger percentage of certain asset categories (for example international stocks) than may be desired. So it is important to understand and be aware of everything that the target date fund is investing in to make sure it suits your risk profile, goals, and needs. Not all target date funds have the same allocations and this can make a difference in the comparative long-term performance of one target date fund versus another.
Customization to Personal Needs and Circumstances
With respect to target date funds the ‘target date’ should be set based on a number of factors including risk profile, liquidity, goals, and income/expense analysis. So individual circumstances need to be factored in and there is no one size fits all answer. An important question to ask when choosing among target-date funds: Is this a “to” fund, in which the allocation path freezes your asset allocation the year you plan to retire, or a “through” fund that continues the allocation path for 10 years or more past retirement before freezing your asset allocation. The philosophy of “through” funds is that life doesn’t stop at retirement. You still may have 20-30 years or more of living expenses, and the risk profile of a target date fund should reflect that with respect to the way they can allow your money to compound and grow.
Factors to Evaluate When Choosing a Target Date Fund
Before making a decision as to whether a target date fund is a good investment for your needs, check the fund’s fact sheet or prospectus to find out what the fund’s stated mission is, how it is currently allocated, and what its future path will be. Also remember to check the fund’s expense ratio since that will determine what you will pay in annual fees.
