(Two side notes: all funds that I discuss will be the 2040 version, I do not own any of these funds and am not recommending them I selected them for example purposes only so it would be easier to see what I am discussing.)

May not match your risk preference

The fund may end up taking on much more risk than you would normally consider taking in an investment (or possibly less risk).  For example, the John Hancock fund has a 2.2% currency strategy position.  So beyond stocks and bonds it is also investing in things such as commodities and currencies.  Fidelity Freedom has close to a 9% allocation towards commodity/other funds, while the Vanguard fund has no commodities/other exposure.

Many people would consider an investment in currencies or commodities to be very risky and not necessarily want them in their portfolio.   You need to decide your comfort level in being invested in these, obviously the smaller the percentage the less the risk, but it still is there.  (To give you an idea of my comfort level, I only have 3% of our assets in commodities and only added those once the nest egg was big enough that 3% was not going to make or break it!)

Along with investments that you would normally not consider, the funds may also take an allocation percentage (how much you commit to each class of investments such as stocks and bonds) that you would not use.  This impacts you not only today but as you get closer to retirement, as this will adjust.

So if you are comfortable with the allocation today, you may not be as the allocation closer to retirement changes.  For example the Fidelity Fund 10 years after retirement targets 20% in stocks, while the Vanguard fund 10 years after retirement targets 30% stocks.  While as it stands today Fidelity has 72% in stocks and Vanguard has 88% in stocks.  These are fairly big differences in investment allocations for the same retirement date.  (Dont forget when looking at the current difference that Vanguard is higher in stocks because they do not use commodities while Fidelity does.)

Still Untested

Target Date funds were created in 1993 by BGI and WellsFargo .  While you may consider 19 years a long time, when you consider that as a 21 year old you would have forty four years to save for retirement the target date funds have not existed long enough for a new worker to get to retirement.  When you are in it for retirement, it is hard to judge a product that has not run the full span of its appointed task.

Expenses can be High

Fees can kill your investment return.  So it does not help that with the target date funds two sets of fees come into play.  The first is the expense ratio for the fund itself.  The second is the expense ratio for the underlying funds.  Because of this, you may be paying more in fees than is healthy for your portfolio.

The Vanguard fund has an expense ratio of .19%, plus its underlying funds charge between .17% and .22% for a possible total of .41% which is actually pretty good.  Comparatively Fidelity Freedom has an expense ratio of .78%.  With a range of .20% to 1.13% in the funds within the fund, making up a possible fee of 1.91% which is high!  I even found funds that had expense ratios of 1.88% in addition to the underlying assets (State Farm) and 2.10% (PIMCO), which could possibly push you into total fees of 3%.  Three percent in fees is a HUGE hurdle to creating retirement wealth; it is the equivalent of trying to overcome inflation two times!

Only as Good as the Investment Company

Most target date funds use funds from their own company to create your portfolio.  Thus if you use the Vanguard fund then it will contain Vanguard funds, likewise Fidelity will use Fidelity funds.  This means that your investments are only as good as the company.  You need to ensure the family of funds has a strong history of good performance.  This becomes harder to track for companies such as State Farm, which hires out a firm to manage their funds for them, at this time they have hired BlackRock but this can change at any time if State Farm decides to hire a new manager.  This makes it harder for you to keep track of the quality.

How to Decide if the Target Date Fund in Your 401K is Good

Using the problems that we discussed above there are four things you should look at to determine if you should invest in the target date fund in your retirement plan.

Look at the Current Allocation and the Future Allocations

First you want to make sure that the level of risk that the fund is taking is what you find acceptable.  (Not sure what your asset allocation should be?  Here is my favorite chart to help you decide.)

To do this you can do this one of two ways:

1. Go to the fund companies website, find the fund and within their information you should find a list of the current assets.  For example at Vanguard if you go to the investor site and then key in the ticker symbol you can find a summary of information with a tab for the Portfolio (see the picture below).  This tab will show you the allocation to stocks and bonds, plus the actual funds that it is invested in.

Vanguard Summary

2. Go to Morningstar.com and at the top of the page, type in the ticker symbol in the quote box.  Then click on the  portfolio tab.  Here you will find the allocations and the current mutual funds being used.

Then while you are there check to see what the pace of moving from stocks to bonds is the closer you get to retirement (the glide path).  On the funds sites it varies as to where they put this, some include it in their summary information, and while others you need to open up the prospectus.  At the Morningstar site simply scroll to the bottom of the portfolio tab and it will have a glide path to show you the progression.

Glide Path Example

Remember, even if the guidelines are in line for everything that is recommended if you are uncomfortable with the investments inside the fund then you should not invest in them.  You still need to sleep at night and you need to be comfortable with where your money is at.  You can build a more conservative portfolio using individual funds to suit your needs instead.  Just remember you may need to save more to get to where you want to be.

Look at the Expenses

For this step you can continue to use the two resources from the above section.  You will want to look up not only the funds cost, but also the cost on the underlying funds.

On the funds website the information on the cost of the target date fund should be on the summary page.  Then to get the cost of the underlying funds you need to head to the portfolio information and take a look at each of those funds.  (You will notice in the Vanguard picture above that it lists out the funds right below the allocation.)  Once you have those you can search for each of those funds on the site and go to its summary page to get the expense ratio.  Adding the two together gets your total expense exposure.

On Morningstar it is a bit easier, on the portfolio page at the top click on Holdings and then scroll to the bottom.  Here you will see a list of funds, you can actually click on the fund name and it will open a new tab for that fund, from here you can click on quote and see the fees! (Some funds are not clickable as that means they typically are an individual investment that only the fund company can get).

While determining the exact amount of fees that is acceptable can be difficult since there is no right or wrong answer, I would recommend you try and stay under 1.25% and preferably under 1%. I did write a post on fees if you need more information on why fees are bad for your investments.  The Impact of Fees on Mutual Funds

Check the Management Company

This is probably the hardest thing to measure, as many fund companies have fantastic funds and also some bad funds.

Other than going fund by fund, I recommend heading to Morningstar and using their Fund Family pages.  These are not overly easy to find as they dont have a link on a specific page.  Instead you need to head to the bottom of the page, select the Site map and then under Mutual Fund Performance data you can select the fund company you are looking at.  Once you click on that fund you can do a quick scan of the fund companies funds, rating and returns. Then click on the words Data Pages next to the name of the fund company, it will take you to a snap shot page that includes averages for expenses, returns and lots of other great information.

By scanning this information you should be able to determine if across the board fees are reasonable and how many funds are on the bad side that you may be invested into.

Example of Fund Company Information

What other Funds are an Option in Your 401k

Once you have looked at the target date fund before you decide to pay the extra fee to have someone do your allocations for you, check out the other funds available in your plan.  Can you easily select a balance based on your desired allocation?  Are those funds better and cheaper?  Let’s say your 401K also has an index fund for the total market, an international index and a bond fund, you may be better off with a mixture of these than a target date fund just based on fees.

Are you going to reallocate?

Finally assuming that the risk levels are acceptable, the fees are good and you are happy with the fund company.  You need to decide if you would rather set it and forget it with a target date fund, or if you would once a year re-balance your portfolio and adjust your allocations as you get closer to retirement.  If you can guarantee that you won’t touch it after you set it then a target date fund is probably the best.  If you will sit down once a year and make sure you are on track, then you may be better off picking individual funds.

Ultimately it is a decision that can only be made by you.  You need to look at all the information, pair that with your personality and habits to create a winning investment plan for you.  Happy Investing!

Hey Andrea

This is a great breakdown of target date funds. Part of my 401(k) is in a Fidelity target date fund. I originally got into it to put part of my portfolio in passive mode. But, Ive been less than impressed with its performance vs the S&P 500 over the last 2 years. Im considering moving it to a different target date fund. This post will be a great resource for where to look when researching a new target date fund.

Happy Birthday & 40 is not old! I am not familiar with Bankers life, but you should use caution when annuities are in the initial conversation for a 40 year old who is still at the beginning of retirement planning. You are most likely better off with focusing on your IRA or 401K to start with.