Financial Planning, Millennials

What You Need To Know About Target Date Funds

Target date funds are pretty popular these days. You may have seen them in your 401(K) investment options lineup with names like Retire 2050 or Target 2050. 

Target Date Funds are made to simplify things for you. They essentially let you choose one fund that is a blend of several funds. Bonds, big companies, small companies, international companies, etc. will all receive allocations. The farther out from retirement you pick, (ie. 2050 is way farther away than 2030) the more equities it will have. The closer you pick, the more bonds it will have.

For example, a target date fund may start with an 80% allocation to stocks and a 20% allocation to bonds, then overtime move to more 60/40 as you get closer to retirement. The reason target date funds move to more bonds as you approach retirement is simply to reduce risk. The goal is to have enough investments as you get close to retirement that you can start to go into more of a preservation mode than a growth mode.

Let’s go through the good and the bad of Target Date Funds.

What Is Good About Target Date Funds? 

  1. They can be great for people who know very little about investments 

Since you can just pick one fund that has a solid allocation, it can be a great option for those who don’t know what to invest in. It is way better than randomly picking things or leaving your 401(K) in cash. 

  1. They are a low maintenance option 

It is somewhat a set it and forget it option. You just want to make sure it does not get too risky or too conservative for your own individual goals and risk tolerance. 

  1. They can be lost cost

Oftentimes, if you pick a solid target date fund that is made up of ETF’s or Mutual funds, they will be pretty low cost. Keeping your investing fees low can have a massive impact. 

What Is Not So Good About Target Date Funds?

  1. They can vary quite a bit 

If you look at 5 different target date funds, they can all be quite different. Some have more bonds than others. Some have more international than others. You want to look and make sure you agree with the mix in it if you can. 

  1. They can be too conservative 

Sure, you may be planning to retire in 2040, but what if you do not plan to touch your 401(k) assets for another 10 or 15 years. The portfolio will automatically scale back risk and have a lot in bonds. I tend to like the bucketed approach for retirement where we have a couple years in cash, a mid term investment bucket with less risk, then a long term bucket that still has a good amount of equities in it. If all your money is in a 401(K) target date fund, you may be way off on this. 

  1. They offer very little customization 

You do not have the choice to really customize it all. What if you don’t like the allocation and want more equities or more bonds based on your risk score? You could pick a different target date but that does not necessarily mean it is right for you. You also are limited to one fund company’s target date option which I never love either. 

  1. Fees Can Vary

I know, I know, above I said fees are low. However, that is not always the case. One employer may have a Target date fund that costs .2%. While another may be .6-1%. Look into the fees and make sure you have a good option available. 

At the end of the day, target date funds are a fine option. However, if you have an advisor, creating the right portfolio based on your needs, goals, retirement date, risk tolerance, etc is a way better option. And a quick piece of advice, do not just go and pick 4 different target date funds. They are all basically the same with just small tilts to more or less bonds and equities. If you pick a target date fund as your strategy, that is fine, but pick the one that is right for you. Not all of them. 

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