Many investors look to target date funds to set-and-forget their retirement investments, but are they actually the right investment choice for you? Although target-date funds might seem like the perfect solution, it’s important to truly understand how they work and whether or not they fit your long-term savings goals.
What Is a Target Date Fund?
A target-date fund is offered by investment companies as an easy solution for people who are looking to invest their money and not be overly concerned about asset allocation over the course of their next several years (or until they retire). Just like their name suggests, target-date funds set up your investments to continue to adjust themselves to grow your wealth based on ideal asset allocation with the idea that you’ll start to take money out of the account at the specified target date.
Many people choose target-date funds when they’re looking to DIY their retirement savings because it takes a lot of the guesswork out of the investing process. Unfortunately, the old saying holds true: if it seems to good to be true, it probably is. Although they work for some people, for others they not the best option available.
When Do They Make Sense?
If you have a target date fund option through your 401(k), you’re probably limited to only one option from one fund manager. Whether you only have one option, or you’re considering target-date funds for your retirement savings outside of your workplace, you’re looking for a few key factors:
A glide path that matches your goals timeline (retirement, a large purchase, etc.)
An investing strategy that’s going to get you both to and through your “target date” to grow your savings throughout your years as a retiree
Some target-date funds are worthwhile, but it can be tricky to find one that’s a perfect fit. Too many people use a target-date fund that’s “close enough” - and you deserve better than that when it comes to your retirement plan! The problem that investors often run into is that there are so many options when it comes to picking a target-date fund. That’s why sitting down with your financial planning team at Michael Brady & Co can be a big help when it comes to determining which target-date fund is right for you and your long-term financial and lifestyle goals.
When Should You Reconsider?
It’s all too common for target-date funds to be a poor match for investors. Investors who want to DIY, but aren’t interested in doing the legwork or research to figure out which funds are a perfect match for their goals, and they end up falling prey to “drone investing.” Drone investing lends itself to complacency, which shouldn’t be part of any investor’s strategy. When investors become complacent, they miss key indicators that could mean their portfolio is holding more risk than they want given their “target date” timeline.
Caution: Check Your Fees
It’s always important to check your fees when it comes to investing. This is especially true with target-date funds that have notoriously higher-than-average fees associated with them. Although most target-date funds are relatively hands-off, which equates to lower fees, this isn’t always true. Many target-date funds hold equity investments, which might mean that your fund is invested much more aggressively than you realize.
If this strategy is intended to not just get you to but through your retirement (based on the glide path your target-date fund is using), then you might still be in the clear. However, if the equity investments your target-date fund holds exist solely because they have high fees (which could be passed on to you - with a markup), you need to be careful.
Other target-date funds are actively managed, which can also result in hefty fees paid to fund managers. To avoid either of these fee traps, look for target-date funds that specifically use low-cost index funds or passively-managed target-date funds because they will usually have lower fees (and carry lower risk).
Target-date funds seem like an easy, one-size-fits-all solution for the DIY investor. Unfortunately, this isn’t the case, and even seasoned investors can get stuck with a target-date fund that isn’t ideal for them. If you’re considering a target-date fund for your workplace retirement account, or for another investment vehicle in your portfolio - talk to a financial planner before moving forward. Even if you’re already invested in a target-date fund, it doesn’t hurt to have a financial planner review your investments with you to make sure they’re aligned with your goals.