Target Date Funds: What You Need to Know

When creating your retirement savings plan, it's helpful to have specific goals. One such goal is when you plan to retire. Some of you might even have a specific date when you hope to retire. Target date funds are a popular retirement investment strategy that, as their name suggests, target a specific retirement date.

They're a popular option for 401k plans—and their popularity increases each year. According to a recent study by the Investment Company Institute, participants in their twenties had over 50% of their 401k funds allocated to target date funds. 65% of those hired within the past two years had investments in target date funds.

They're so ubiquitous that it's possible your employer signed you up for one as a default 401k option.

I believe that, when it comes to your retirement, you should make informed investment choices. So, let's look more closely at target date funds so you can figure out whether they're right for you—and what to do if they aren't.

The problem with target date funds

While target date funds offer some benefits, they come with some important drawbacks. These drawbacks can have serious effects on your retirement plans, including falling short of your goals. Since most retirees survive on a fixed income, not meeting those goals can have serious consequences, such as continuing to work beyond retirement age.

Here are six major drawbacks to target date funds you should consider when planning for your retirement.

One plan for all investors

Target date funds are designed to build toward a specific retirement date. That is literally their only goal. They don't account for your individual needs and goals. Your dream retirement is of no concern to the fund, making building toward it difficult, if not impossible.

It's a one-size-fits-all scenario. Unfortunately, retirement goals come in all shapes and sizes, making it unlikely that a target date fund would actually fit your needs. In those instances, there's a good chance that the fund will fall short of how much you need to retire, forcing you to make major adjustments to your plans very late in the game.

Extremely variable

If you search for specific holdings of individual target date funds, you might become surprised or confused that each target date fund has its own mix of investments, asset allocation, and growth rates. The variation between each fund is so great, if you don't choose a specific fund, it's impossible to predict what you're getting and what your retirement income might be.

Once you include other variables, such as management options and fees, it might feel even more difficult to decide which one might be best. This makes the possibility of your employer picking a plan best suited to your individual needs a little like finding a specific needle within a box of similar-looking needles all designed for a different use—without knowing which one you need to find!

All investments owned by one company

To be fair, target date funds do their best to offer a diverse portfolio. They usually include a variety of asset classes, including a mix of mutual funds, index funds, and both domestic and international stocks and bonds.

On the surface, this seems to meet the requirements for diversification. But here's a secret: each individual fund included in your target date fund is owned by the same company. Typically, this is the company providing the fund to you. So, in reality, your diversification options are severely limited. This can make finding the correct mix of investments to meet your goals more difficult than it needs to be.

No active management

One of the primary goals of target date funds is simplicity. This includes a simple management system. Most target date funds managers make minimal adjustments to your investments. Usually, these are timed maneuvers: as you get closer to retirement, the manager might move your money into safer investments.

Compare this to a financial advisor or other investment managers who can offer a more active, personalized service. They can watch the market and make in-the-moment adjustments to help you build toward your specific retirement goals.

Playing it safe

As I mentioned above, as you get closer to retirement, your fund manager gradually shifts your money into safer investments, even if you don't ask for it. However, this can have a significant impact on your retirement.

The last few years of your working life is a perfect time to catch up on your savings and make sure you reach your retirement income goals. In fact, many retirement plans increase your contribution limits once you hit 50 years of age. This ability to make adjustments to your retirement plans and maximize your earnings as you prepare to leave the workforce is an important part of later-in-life investing.

Unfortunately, the only plan target date fund managers have during this important period is to become more conservative. That's understandable, since it helps ensure you don't lose money right before retirement. But it also limits your ability to grow, which is something many of us need just before we retire.

Hidden fees

A big selling point of target date funds is that they come with a low expense ratio. And while this is true, it's only half of the story. A target date fund is usually a fund of funds: it's an overarching fund comprised of many mutual funds and investments. They also come with two layers of fees: the overall management fee and the fund-of-funds fee.

Here's another secret: target date funds are allowed to only show you the fund-of-funds fee. This gives them the opportunity to set a low fund-of-funds fee while keeping their larger overall management fee hidden from you until it's too late.

How a 401k rollover can help

Do you know how to perform a 401k rollover? It's the process of taking the money from your current 401k and reinvesting it into a new one. It's a simple process that you can accomplish in three easy steps!

If you currently have a target date fund set as your 401k plan and would like to change it, performing a rollover can help. First, you need to find your options. It might take a bit of research, but the payoff could be a better retirement. Some ways to discover your 401k options include:

  • Asking your employer
  • Looking them up on an employee portal
  • Logging into your account on the provider's website
  • Calling the provider directly

Once you find out whether you have 401k options beyond a target date fund, you can select the one that best suits your retirement goals and initiate a rollover.

Typically, you can only contribute to a 401k if your employer sponsors one. If you're self-employed, you might find a solo provider who offers the plan and account management you prefer.

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