Retirement-plan investors often aren’t sure how to allocate
the money they’re socking away in their 401(k) accounts. So the rise of
target-date funds—which automatically shift investors’ money from stocks to
fixed income gradually over the years—has been widely heralded as a victory for
the country’s retirement readiness. Indeed, many employer-sponsored retirement
plans now use target-date funds as their default option when employees are
automatically enrolled. Target-date funds are expected to hold about 35% of
total 401(k) assets by 2019, up from 13.5% in 2013, according to Cerulli
Associates, a research firm based in Boston.
Some observers worry that some investors who don’t fully
understand these funds might take on more risk than they want. The target-date
approach was tested in the 2008 financial crisis, and many investors were
surprised by the declines in their funds.
Proponents say target-date funds keep investors on track,
preventing overreactions to market volatility. And, some argue, while
target-date funds aren’t immune to declines, their ability to recover rapidly
from downturns means they remain a good deal for investors.
A report published in September by Charles Schwab Corp.,
which manages several target-date funds, said funds with end dates of 2010 and
2040 both performed well after the 2008 financial crisis. The Schwab report says that on average,
$100,000 in a fund at the end of 2007 with a retirement target between 2036 and
2040—aimed at younger investors, who have many years until retirement—would
have become $123,327 by the end of 2013. For a fund with a 2000 to 2010
retirement date, $100,000 at the end of 2007 would have become $125,833 on
average by the end of 2013, Schwab says.
Making a Choice
Still, it’s important for investors to make an informed
decision about whether to invest their 401(k) money in a target-date fund or in
other options. The first step in evaluating a target-date fund is to check the
prospectus to determine the glide path—the changes in allocations over time—to
make sure the fund is taking an amount of risk over the years that the investor
is comfortable with.
Investors should be aware that target-date funds take one of
two basic approaches: The “to retirement” funds finish their allocation changes
by the investor’s projected retirement date, while “through retirement” funds
continue to switch from stocks into fixed income until a later date, often at
age 72, says Erik Daley, managing principal at Multnomah Group, a consulting
firm for retirement plans. Knowing which of those approaches a fund takes is
crucial in deciding whether it matches an investor’s risk tolerance.
As with any fund, investors should also be aware of fees.
The largest providers of target-date funds— T. Rowe Price Group, Fidelity
Investments and Vanguard Group—all offer low-fee funds, either actively managed
or passive and index-based. Investors should seek out funds with expense ratios
below the average, which was 0.84% for target-date funds at the end of 2013.
Typically, 401(k) plans offer a series of target-date funds
from the same fund company, so investors who can’t find one with low fees and
their preferred risk profile might prefer to do things the old-fashioned
way—invest in the stock and bond funds their plan offers and commit to doing
the rebalancing in the years ahead themselves.
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