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If you participate in a 401(k) plan at work, you likely have the option to invest in so-called target date funds, also known as retirement date funds or lifecycle funds.
At the end of 2020, the majority of plans (86%) offered target-date funds, and 59% of 401(k) participants had invested money in one.
That’s according to an analysis by the Employee Benefit Research Institute, which examined anonymous data from 11.5 million 401(k) participant accounts from employers of all sizes.
So what exactly is a target-date fund? It’s an all-in-one portfolio of stocks and bonds designed to give the average investor a good allocation for their expected retirement date. I am. In other words, you would choose a fund that targets a retirement year closest to the year you turn 65. For example, if you’re 25 years old, you might invest in a fund with a 2065 target date. If you say she is 50 years old, you would choose the 2040 fund.
One reason for the high percentage of 401(k) participants who have money in target-date funds is that employees who are automatically enrolled in a plan or whose plan changes after a merger are This is because the fund is often the default investment.
Target date funds are typically “funds of funds.” That is, its portfolio consists of both stock and bond funds selected by the manager.
Each target date fund has a “glide path” for future allocations that are intended to increase more conservatively over time. For example, a fund that targets a retirement date 40 years from now will be invested primarily in stocks (for example, 90% stocks and 10% bonds). On the other hand, if the target date is only a few years away, the fund may invest less. Madison Sharik, a certified financial planner with Muddy Manages Money, said your stock allocation could be even lower by your actual retirement year.
And those underlying funds could be index funds that track a specific market or sector, or the broader stock or bond market. As an example, Vanguard says that target-date funds invest in Vanguard’s broadest range of index funds, essentially providing exposure to “thousands of U.S. and international stocks and bonds.” points out.
In addition to adjusting a fund’s allocation as retirement approaches, fund managers regularly make adjustments to ensure that their chosen asset allocation for the year is not too upset by market performance, says Brian Minogue, a certified financial planner at Cardinal. The balance of the portfolio will be adjusted accordingly. Finance.
For example, Minogue noted that the fund may make quarterly adjustments to ensure it sticks to its assigned allocation (e.g., 70% stocks, 30% bonds). Alternatively, it may be adjusted every time the stock or bond portion of the portfolio moves up or down by, say, 5% or more.
Before deciding whether a target-date fund is the right investment for your needs, review the fund’s fact sheet or prospectus to understand what the fund’s stated mission is and how it is currently allocated. Find out what the current glide path will be in the future. .
And importantly, check the fund’s expense ratio, as this will determine how much you will pay in annual fees. Ideally, you want your expense ratio to be less than 0.3%, Sharik said. For example, let’s say the fund’s expense ratio is 0.2%. That means you pay an annual fee of $20 for every $10,000 you invest (0.2% x $10,000).
In addition to gathering that information, Stacey, a certified financial planner based in Tampa, Fla., explains that the fund assumes a certain risk tolerance and set of investment goals, and that the “average” investor You should think of it as designed to help, says Stacey, a certified financial planner based in Tampa, Florida. Mr. Miller.
In your 50s, it’s especially important to revisit your fund’s glide path up until your retirement date (and possibly beyond). If you are healthy and expect to live more than 20 years in retirement, make sure the target-date fund’s planned stock allocation can provide enough growth for your portfolio to suit your needs and preferences.
“As pre-retirees approach their ‘target date’ for retirement, some funds are starting to move away from equity positions entirely and into bonds. “Depending on an investor’s risk profile, this could have a negative impact on long-term retirement goals,” Miller said.
When helping clients find the best way to invest in their 401(k), Minogue always targets – Said to recommend date fund options. low cost.
And for plans where target-date funds are the only option, “it’s a great default option,” he said.
In addition to reading the fine print about what your target fund aims to do and how it does it, be honest with yourself about what type of investor you are.
If you are willing to take on more risk than the average person and actively manage and rebalance your portfolio yourself, you may find that your money is too constrained by a target-date fund.
However, if you don’t have enough confidence or, frankly, enough interest to actively manage your retirement savings, target date funds may be a good option.
“Target-date funds are perfect for people who overanalyze, overthink, or just don’t want to worry about that,” Sharik says.