Target-Date Retirement Funds Are an Easy Retirement Investment Option

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A target date retirement fund, also known as a lifecycle fund, is a mutual fund that adjusts its asset allocation according to the amount of years its investors have until retirement. These funds have surged in popularity in the past five years, and today about half of new 401(k) plan users select a target-date retirement fund. It’s an easy option for investors who don’t want to think about rebalancing their portfolios or worrying about allocation. Pick a risk tolerance and a time frame, set it and forget it.

All of these funds invest in stocks, bonds and cash. But the proportions matter. And the proportion you choose may have more to do with your own risk tolerance than your actual target date for retirement. Say, for example, that you plan to retire in 2035. You could easily pick a 2035 target fund today that invests in 75% stocks or growth investments, and 20% bonds or fixed-income investments, and 5% in cash. As the calendar approaches 2035, the becomes more and more conservative, shifting a greater proportion to bonds, and a lesser amount to stocks.

However, even if you plan to retire in 2035, you may want something more conservative than that. You might want to invest in a fund with a nearer target date. You could find a 2020 fund with 60% stocks and 40% bonds and cash. Or you could choose something a bit more aggressive, say a 2050 fund that invests primarily in stocks. The point is to look beyond the fund’s name and date. Instead, pay attention to the allocation that works for you. And keep an eye one it. The allocation will shift slightly over time. Keep watch to make sure you are still as comfortable with those numbers as you age. Plus, most of these funds don’t take into consideration that you want to invest through retirement, not just stop at a predetermined retirement date.

Benefits of Target Date Retirement Funds

One of the reasons target-date funds are so popular is they make easy for investors who don’t want to have to think too much about their investment choices once they are made. Studies show that more than half of retirement plan investors don’t understand asset allocation principles. And retirements can suffer because of it.

The typical 401(k) plan offers 12 to 18 choices these days. That’s a lot for the average person to think about. How much international do you need? What is a small-cap? And what if the market takes a turn for the worse? Do you move your money around now or wait it out? It’s a lot easier to have an expert—or even an index—do the work for you. Once you’ve determined your comfort with risk, set up automatic contributions, you are on track for retirement.

What to Look for in a Target-Date Retirement Fund

There are critics of target-date retirement funds. Because they are relatively new types of investments, there are no set regulations. How managers will run them and how they will perform over the long term is still in question. Some Here’s what to pay attention to when considering a target-date retirement fund.

Asset allocation: When Morningstar did a comparison of funds with the target date of 2025, it found that the allocation to stocks varied from 38% to 86%. A wide spread, to say the least. So don’t assume that the manager agrees with your definition of an aggressive or conservative asset allocation. Pay attention to how the money is allocated before selecting a fund for you.

Fees: All fund investors should be mindful of fees. because over time they can eat away at the value of the fund. Fortunately, as money continues to pour into target-date retirement funds, fees are on the decline. Morningstar found that the average expense ratio for target-date funds is 0.61%. Actively managed funds are more expensive, although historically active management does not help outperform index funds. The expense ratios for Vangaurd’s target-date retirement index funds are below 0.20%. (Vanguard, Fidelity, and T. Rowe Price manage the lion’s share of target-date retirement fund dollars.)

Focus: Finally, a target-date retirement fund only really works if you put all contributions into the one fund. Use it in a portfolio of other funds, and you aren’t getting the asset allocation that the target-date fund promises.

So do a little research on your 401(k)’s target-date retirement offering. And your savings could be on target.

Disclaimer: The content on this site is provided for information and discussion purposes only, and should not be misconstrued as investment advice. Under no circumstances does this information represent a recommendation to buy or sell securities.