Why Relying Only On Target Date Funds May Hurt Future Retirement Account Performance
If you’re like most investors, your 401(k) or other workplace retirement plan can represent a significant portion of your assets. For many, it is the largest asset.
That said, more investors than ever are following this one piece of advice from fund managers or a company’s plan representative, and are making choices for their plan that don’t allow them to potentially maximize income at retirement.
Sadly, this popular advice is systematically disconnecting people from their 401(k)s.
And to make matters worse, our industry says it’s hard to be a successful investor, and, therefore, there’s very little education and training that goes into investing for retirement.
The result: people are turning a blind eye to what’s happening with their plans and hoping they will have enough money in retirement.
Hope isn’t a strategy, folks.
So what is this advice that may be working to undermine your retirement savings?
Target date funds. These are also referred to as lifestyle funds and retirement date funds. (We’re talking about 2030, 2040, and 2050 funds.)
Target date funds have become extremely popular with 401(k) participants throughout the past few years, and it’s easy to understand why.
However, this is something successful investors avoid.
Keep reading to discover what a target date fund is, how it works, and why it isn’t as beneficial as you think….
What Exactly Is a Target Date Fund?
A target date fund is a fund offered by an investment company that’s structured to meet capital needed at some date in the future, such as retirement. The asset allocation of a target date fund is based on a predetermined retirement date.
Target date funds are structured to automatically reallocate as you move through different life stages.
And, as you age toward your target retirement date, the funds shift toward more conservative investments to protect your money.
For many 401(k) investors, this sounds like a win-win. Invest your money, and let it do its thing until retirement.
But here’s the problem…
The Downside of Investing in Target Date Funds
Target date funds were created to take away the hassle of having to research mutual funds in your 401(k) and build and construct your own portfolio.
Instead of having to choose a number of investments and create a portfolio, you can just select a fund that will help you reach retirement income goals.
It’s no wonder target date funds are so popular with 401(k) plan investors…you set it up and forget about it.
Herein lies the problem.
Because target date funds are based on the date of retirement, they fail to take into consideration that not all investors are created equal.
In addition, target date funds may often underperform in good markets and do a poor job of managing downside risk during tough markets.
Because we’re committed to helping investors like you improve your workplace retirement account performance and manage downside risk, we really want you to get this.
So let’s break it down, shall we?
One-Size-Fits-All Investment Strategy May Be a Recipe for Disaster and Disappointment
Most companies’ 401(k) plans will use TDFs as their go-to or “default” option.
People just like you are told by fund managers or their company’s plan representatives to invest in target date or lifestyle funds because they are supposed to automatically adjust account allocations throughout your life.
So, if you’re younger and plan to retire in 2060, you’re told to select a 2060 fund. If you’re older and wanting to retire in 2030, you’d select a 2030 target date fund.
What this means is investors are grouped solely based on their expected retirement date–location, age, profession, salary, risk tolerance, goals, and objectives are NOT taken into consideration.
Another way of putting it: not everyone retiring in 2030 has the same goals, objectives, risk tolerance, profession, or salary.
Investing in target date funds and sitting back and not actively managing your retirement account is equivalent to saying there’s a one-size-fits-all investment strategy that works for everyone.
It’s just not the case.
That’s not to say target date funds aren’t more beneficial for some investors over others. They can be.
But for a majority of investors, there is a downside to target date funds, and, as a result, you may be leaving money on the table every year.
Investors A and B are the same age and are both set to retire in 2027.
Investor A has been actively investing in her retirement account for 30 years. She has a senior level position at a company she’s been with for decades. And she’s actively managed her 401(k) account throughout the years. Her #1 concern right now is protecting her money this close to retirement.
Investor B has been saving for 30 years as well, but he has worked for 5 different companies, is middle management, and has not received pay that goes with senior level management. He has had financial troubles and hasn’t been able to maximize his retirement savings. He feels he needs to be more aggressive to make up for lost time.
Investor A and Investor B are VERY different investors.
Does it make sense that they are in the same investment strategy?
If your answer is Heck N0!, you’re correct! This doesn’t even pass the common sense test!
This example shows exactly why target date funds can have potential to cause more harm than good.
Is that a risk that you want to take with your retirement assets?
Click here to discover How to Supercharge Your 401(k) Performance Today.
Target Date Funds May Not Appropriately Manage Downside Risk
Another reason it’s essential to diversify your 401(k) or other workplace retirement accounts and not rely solely on target date funds is because they may not appropriately manage downside risk.
The reality is that target date funds will often underperform in good markets and do a poor job of managing downside risk during tough markets.
In fact, according to Morningstar Analyst Jeffrey Holt, ”In the long run, the biggest risk in target date funds is that they won’t meet expectations for avoiding losses.”¹
Another problem is they do not take into consideration changes in the economy, tax policy, trade, earning reports, or investment trends. They may not make adjustment for any of these driving factors that affect investment performance.
Becoming a Successful 401(k) Investor May Be Easier Than You Think
Sadly, our industry has done a dang good job of telling you it’s difficult to be a savvy investor.
We’re here to tell you managing your 401(k) or workplace retirement plan isn’t as difficult as you think.
At 401(k) Maneuver, we believe that when you invest in yourself and when you grow your skill set, then you can do anything you put your mind to.
And that knowledge is something no one can take away from you.
If you’d like to take control of your financial future and have more income at retirement, download our guide on How To Supercharge Your 401(k) Performance Today.
Sources:
1. “Special Report: Fidelity puts 6 million savers on risky path to retirement”, Tim McLaughlin, Renee Dudley Reuters, March 5, 2018
