Target Date Funds 101
At their core, Target Date Funds (commonly referred to as TDFs) combine stock and bond funds together to form a “fund of funds” based on the target date of when the participant (or investor) turns 65. They are designed to be the only fund in your company’s retirement plan account.
TDFs are based on the idea of favoring maximum exposure to the market (more frankly put: exposure to its risk) when you are young, and then to reduce that risk as you age by decreasing the amount of stock exposure and increasing the amount of bonds in your account.
TDFs are not inherently good nor bad. They can, at times, serve a very valuable purpose-- but they are not right for everyone. Here's an important fact about TDFs that you may not know:
TDFs are generally the default investment option that a company retirement plan offers. That means if your employer automatically enrolls you into the 401K plan, they will “default” you into the target date fund tied to the year that is closest to your 65th birthday, and you must actively change it if you want to use a different strategy.
Target date funds may be a good option for unsophisticated investors or investors who just don't have any interest in learning how to manage their retirement assets. However, I believe it is essential to be able to confidently manage your 401k yourself. So, my goal is to help you demystify your 401k plan so that you are able and eager to do so.
It is important to highlight that not all TDFs are created equal. There are two main differences among TDFs: the asset allocation mix and the “Glide Path”.
The asset allocation mix is the manner in which different asset classes (Large Cap, Small Cap, International, etc) are blended in the TDF and the percentages of each strategy.
The Glide Path can be thought of as a dimmer switch that decreases your risk slowly overtime. The term dustup within the industry is defined as how aggressively each company applies that dimmer switch and which asset allocation they choose. I'd say, generally, that the way the glide path changes over time are considered to be the most controversial of the two.
There are also two glide paths methods: “To Retirement” and “Through retirement”.
“To” applies its final adjustment when the fund reaches the target date (2030, 2040, 2050, etc.) and stays at that level for the rest of the fund's life. “Through” does not reach its final adjustment until sometime after the target date. It can even take as long as 15 years before the allocations become static. This can result in vastly different results for investors as the industry can range from a high of 64% to a low of 8% at age 65.
The average worker changes jobs 5-7 times during their career, so, there is a very real possibility that your TDFs will vastly differ from job to job. And without uniformity among fund companies, participants are left to fend for themselves as they approach the Retirement Risk Zone (five years before and after retirement). This zone is when the investors are the most vulnerable to market conditions, and, if each glide path is different-- how can investors protect themselves? This predicament is the precise reason why I advocate the importance of learning to manage your own account or to elect a professional do it for you.
Stay tuned for more blog posts as I go into more detail on how to manage your own investments.