Target date mutual funds have become the most popular choice of retirement plan investors. They appeal to savers because of their implicit promise to take the work out of making investment decisions.
They appeal to the company sponsoring the plan, because they have been deemed a "safe harbor" default investment -- into which the company can automatically direct your retirement contributions, without liability.
And financial consultants like target date funds because they provide the self-discipline that most investors lack -- automatically restructuring the portfolio when it becomes unbalanced because of gains (or losses) in a specific sector.
All those reasons have led to more than half of all 40l(k) assets now being held in target date funds. But before you think that target date plans will solve all your retirement investment issues, you should understand these five factors:
1. Not all target date funds are invested in the same way. Different fund management companies have different percentages invested in stocks (vs. bonds or even money market funds) even in the same target year. Some are more aggressive, which may be fine if you are young and have longer to contribute. Your contributions may buy funds at a bargain price, as in 2008-09. But that's a problem if your target date fund is invested in a greater percentage of stocks, just as you are getting ready to retire.
2. Costs of target date funds can vary widely. For example, target date funds from Vanguard carry an annual cost of less than 0.25 percent, while other funds might have annual charges of more than 1 percent. Those costs add up -- and subtract from your investment results.
3.Not all employees of the same age have the same risk tolerance or goals. If you're a 40-year-old executive, who also has company stock options, outside investments, and a large salary, it may make more sense to have less exposure to aggressive stock market investments inside the plan. Similarly, a lower paid assistant of the same age may actually need more exposure to stocks in order to make a smaller amount of retirement assets work harder toward reaching a retirement goal.
4.Target date funds have a "glide path" -- and not all are the same. The fund management company decides how to glide down to a less aggressive mix of investments inside the target date fund in order to be appropriate retirement goals. But not all fund managers agree on the best mix of investments, especially as the fund approaches its target date for your retirement.
5.Target date funds held during retirement may not be appropriate during your withdrawal years. What do you do with your target date funds after you retire? Take a close look at how these funds continue to invest -- and do some withdrawal modeling. The one thing you don't want to do is be forced to sell stock funds at a loss to make required minimum withdrawals. Work closely with a financial planner to study the mix of all your assets, not just those in your target date funds.
Many 40l(k) and 403(b) plans are now offering individualized investment advice to plan participants. This can give you a broader overview of your risk exposure, diversification, and retirement planning.
Target date funds are far better than the way most people used to make choices -- by guessing or asking a friend or co-worker. But they are not the final answer to retirement security. And that's The Savage Truth.