Most employer sponsored benefit plans now offer target-date funds. These are funds which target your investment allocation based upon your expected retirement date. The investment allocations adjust dynamically over time to reduce risk and provide greater certainty that when you reach your retirement date, your savings will be there to provide for you in your retirement.
How do these funds work?
The funds are named after the year that you expect to retire. If you are thirty years old and plan on retiring in thirty-five years when you reach sixty-five, then your target date will be 2050. By choosing a 2050 target-date fund your savings are channeled into a fund that manages the asset allocations professionally for you. The mix of equity, bond, and money market funds is blended based upon the idea that you can take the most risk and asset volatility during your younger years.
As you age and that retirement year approaches, the risk and volatility gradually reduces. In the final few years before you retire, risk in minimized so that you are more certain that your savings will be there the day you need them.
Why is this important?
Saving for your retirement is an important foundation for your financial security, but many people are either too careful or too risky in their investment allocations.
When faced with a broad selection of investment choices, many investors choose the least risky options because they are unaware or under-educated on investing. Others throw caution to the wind and choose the hottest sounding investment in the hope that it will pay off for them. Neither path leads to a successful investment experience. The too cautious route under-performs the markets, fails to achieve a market based rate of return, and leaves the investor short of savings when they get to their retirement years. The too risky route may provide some great short term gains, but the fireworks can fade too early and leave the investor short of funds to retire on if the markets fade just as he plans on retiring.
The target-date fund provides you with the security that the investment allocations are appropriate for your retirement planning horizon.
What are the pros and cons?
The principle benefit to the target-date fund is that it is automatic. You choose your date and the plan administrator re-balances and channels your savings into the appropriate mix of funds. You don’t have to worry about selecting the right fund for your risk preference or periodically reviewing and re-balancing your plan. The administrator chooses the best funds and keeps the fees as low as possible.
The cons revolve around the idea that a “one size fits all” investment allocation may not be the best for you. There are many external investment considerations that are not reflected in a target-date fund. What if you expect to receive a large inheritance or have other sources of income? Some folks want to take more risk and hopefully retire early. Others want to continue working well beyond their target date. The target-date fund may not account for your particular circumstances.
How do you decide what’s right for you?
The decision on whether to choose a target-date fund should be based on your investing knowledge, education, and propensity to manage your own portfolios. Some people love the challenge of following investment markets and constantly updating their knowledge and skills by reading and attending classes and seminars. Other are less inclined and are more willing to take the generic approach with the certainty that they are following the professionally recommended path. Your particular propensity will guide your decision.
Does it have to be all or nothing?
There is always the option of blending the strategies. Either over your personal life cycle or with a proportion of your assets you can mix and match to your personal needs. If you are just starting out and want to get more investing skills before you commit to running your own allocations, then choose the target fund now with the goal of becoming more active in your investing decisions at a later date. This gives you the confidence that you are not missing out on an important opportunity though your hesitation. If you are more determined to take control of your decisions but less confident in your abilities, then get some assurance of a successful outcome by leaving a portion of your savings in the target-date fund.