Money Talks, So Should You

Target date funds — don't default on your future

Tom Anderson
by Tom Anderson, Dimespring Contributor  (@bytomanderson)

You don't have to know anything about target-date funds – but you will end up in one if you don’t do anything. “Target-date” funds are portfolios that automatically adjust your mix of stocks, bonds and cash, investing more conservatively as you approach your target: retirement.

You need to know how these funds work because you will likely encounter them in your employer’s retirement plan choices. Nearly one in four retirement plan participants invest solely in a target-date fund, according to mutual fund research firm Morningstar. By 2016, Cerulli Associates, a financial services research firm, estimates that these assets, which held $380 billion in 2011, will reach $1.1 trillion.

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Target-date funds are the most popular “default” option in retirement plans after Congress passed a law in 2006. An employer can automatically enroll  or default  you into one of these funds. So if you don’t choose your own investments, your employer may make that decision for you. Don’t default on your future. Get to know target-date funds and how they can help you reach your retirement goals.

Where do I begin?

Decide when you want to retire. Then pick the fund with the year closest to your desired retirement date. Generally, target-date funds are offered in five-year increments. For instance, if you want to retire in 20 years, choose a “2030,” or “2035,” fund, depending on how aggressively you want to invest. The 2035 fund, because of its later target date, would hold more stocks at the time you retire than the 2030 fund.

Exactly how do target-date funds work?

The journey to understanding these funds begins with the “glide path.” That's the slick name given to the formula of how the fund changes its mix of stocks, bonds and cash over time. It's usually depicted graphically as a gently sloping hill.  At the top of the hill, the fund starts with 90 percent or more in stocks and the rest in bonds and cash. Slowly, over decades, the allocation shifts until an investor has about 60 percent in bonds and cash with the remainder in stocks at the target date.

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How the target-date fund moves along the glide path is a large part of what determines its performance. Some funds have a larger allocation of stock closer to the target date than their peers, which may lead to volatile returns in the critical years before you retire. Others hold more fixed income earlier on the glide path, which may mean your nest egg will not grow as fast in bull markets.

How do I choose investments in one of these funds?

You can make your portfolio more aggressive by choosing a target-date fund with a later date, or you can invest more conservatively by picking a fund with an earlier target date. Finally, if you are feeling adventurous, you can build your own portfolio with funds from your retirement plan menu.

Target-date funds vary greatly in the types of stocks and bonds they hold. Since the Great Recession, many fund companies have added more international stocks to juice returns as well as commodities and Treasury inflation-protected securities to hedge, or protect, against the decline of purchasing power. And sometimes even a bond allocation can be misleading because a fund may hold high-yield bonds, which often behave like stocks, or volatile emerging market debt.

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Ask your employer's HR department to explain the glide path and portfolio mix of these funds if you have questions, or call the fund sponsor directly.

Is there anything else I need to know?

Employees who invest in target-date funds – either by choice or default – tend to do better than the average plan participant in study after study. But don’t expect them to meet all of your retirement income needs. These funds don't guarantee income.

According to a recent survey by AllianceBernstein, 51 percent of retirement plan participants thought target-dates thought just the opposite. So maybe putting your 401(k) on autopilot is exactly what you need to do to reach your retirement destination. Choosing a good target-date fund can set you on the right track.


Tom Anderson is a freelance writer in Brooklyn, N.Y. His work has appeared in Forbes, Kiplinger’s Personal Finance and Monocle.