Dear Peggy–My 401(k) plan invested my account in something called a Target Date Fund. What is it, and why did they do that?

on February 20, 2018

In the past, if you didn’t make an investment choice in your retirement plan, the money stayed as cash or money market. However, this caused many individuals to have no growth in their accounts, leaving them unprepared for retirement. As a result, retirement plans now have default investment choices. These choices are blended investments deemed to have an appropriate risk level for the age of the plan participant, and target date funds have become a popular option. Basically, target date funds are structured in five-year increments (2020, 2025, 2030, etc.), and the later the year, the higher percentage of stock in the fund. Closer dates have a higher percentage of bonds, and as a result, theoretically have a lower level of risk because the owner is closer to retirement.

Target date funds can be very effective tools, but it’s important to remember several things. First, they are created by different fund companies, and the risk level (or the percentages of stocks and bonds) varies widely between issuers. As a result, it’s very important to look at the underlying portfolio, even if you ultimately decide to choose the default option. Second, individual factors impact risk tolerance, and the profile of your default fund may not meet your personal risk tolerance. This is easy to control, as choosing a fund with a date prior to your anticipated retirement should be more conservative, and a fund with a date after your retirement should be more aggressive. Finally, target date funds have “glide paths,” or the schedule of how the fund replaces stocks with bonds. It is important to understand the glide path of your target date fund and the final portfolio allocation once the fund is static.

Target date funds can be a useful tool to gain diversification in a risk-adjusted way, especially for investors who want an automated investment process. However, it is important to understand their characteristics, and you should talk to your CFP® professional to see if the investment is appropriate for you.

Even though Peggy is answering questions, this article is educational, not investment advice.  Investing is risky, and you can lose money.  Talk to your financial team about any strategies before you implement them.

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