The popularity of the target-date fund has increased over the years as more plan sponsors make the decision to use these options as Qualified Default Investment Alternatives (QDIA).
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Proponents of the investment options point to statistics stating that 401(k) participants who use target-date funds tend to stay with this investment longer than investors using other core investments offered in their plans.
As many pre-retirees will tell you, you should not blindly invest in a target-date fund without knowing what you are getting into. These funds, as with any investment, need investigation and review to make sure they will meet your retirement needs.
The target-date fund does serve its purpose in the world of investing. Investors, lacking the time or the interest to evaluate their available fund options and build an appropriate mix for their needs, have a one-stop shop. However, using a one-size-fits-all investment has its issues that the individual investor will want to reconcile.Target-date funds are built on a glide path. The idea is that a mix of investments will get generally more conservative as time goes on without the individual investor needing to make any changes. What some investors don’t realize, though, is that not all target-date funds are created with the same end-goal in mind. While some target-date funds look to get more conservative sooner (a “to” retirement approach) others move to a conservative strategy more slowly (a “through” retirement approach).
It is this very “to” or “through” issue that had many near-retirees stumbling in 2008. As target-date funds were introduced to retirement plan participants through 401(k)s, more individuals actively, or in some cases passively through an auto-enroll or default investment option, invested in them believing the funds would do all of the work for them. What some target-date fund investors discovered was that their assets were not as conservative as they believed. This became more pronounced for those investors near retirement. In addition, many plan sponsor employers were caught off-guard as well.
Plan sponsors had good intentions when adding these options to their plans, but some did not understand the underlying components of the target-date fund. Alternatively, in some cases they did not communicate their understanding with enough clarity to help the everyday investor navigate his investment choices.
Ultimately, there were plenty of target-date investors who thought their retirement investments were more protected than they actually were, and they paid the price with steep declines in account value. That’s not to say that target-date funds can’t be a great option—they can be. But every investor has the responsibility to understand the basic objectives of the funds. Moreover, for those nearing retirement, it is even more important to understand just how conservative or aggressive your portfolio is, and how that implicates your retirement needs.
Reading through a fund prospectus isn’t fun for everyone, but it can provide valuable information to help reach your retirement goals, especially if you are depending on a one-size-fits-all approach to your retirement strategy. If you can’t determine if your target-date fund has a glide path that invests to the specified retirement date or through the specified retirement date, then you should request this information from your retirement plan provider or human resources department.
Another option to consider is an asset allocation test. Many online calculators can help you determine your proper mix of investments. Compare your allocation mix from one of these calculators to the mix in the target-date fund you’re considering to see if they closely match. If there is a wide discrepancy, you may want to evaluate a different target-date fund option or use the core fund options in your plan to make your own portfolio.
As with pretty much everything man-made, there is no perfect investment. Each investment will have its ups and downs, and the more you know, the better off you’ll be.
Note: This post is part of the U.S. News & World Report Smarter Inverstor blog series. To view more of our articles, click here.