Choosing the investment options in your 401(k) can be daunting. To help make it easier for investors and capture larger amounts of participants’ monies, financial services companies have increased their offerings of what is known as the Target Date Funds (TDF).
A TDF is a mix of investments including domestic stock, foreign stock cash and bonds. The intent is that when your projected date to retire is years away, you could have more risk in the investment selection but as the retirement date comes closer, the mix of investments is automatically changed to be more conservative.
The date of the fund is designed to correspond to when a plan participant is expected to retire. A lifestyle 2030 plan would be designed for someone planning to retire about your 2030.
The market of the TDF is the person that doesn’t take the time or initiative to look at their 401(k) investments on an annual or other regular basis or they feel they do not know what to invest in to begin with.
If you have a target date fund be aware of the following:
1. Unfortunately, some companies are better at designing these lifestyle funds than others. MorningStar, which is well known for its investment research, recently completed a study looking at the different types of target date funds as well as the sponsors of such funds.
Among the worst performing managers were Massachusetts Mutual Life, Principal Funds Inc., John Hancock funds and ING Investment Management. If you have a TDF from one of these companies you should ask your plan sponsor how the funds are picked and to justify the reason that poorly rated funds are being used.
2. Congress has been investigating the inherent conflict of interest that exists with target date funds that only offer proprietary funds, for example, all investments in the Mass Mutual TDF would be funds that Mass Mutual runs rather than including funds that have lower costs or a better track record.
3. Keep in mind that the fees associated with target date funds can vary dramatically. Higher fees can drain performance over the long haul. Some funds have the cost of the funds being utilized plus a fee on top of base funds. All else being equal an investor should choose the investments with lesser cost.
4. The correct asst allocation should never be based on the date of the goal but should also be based on the risk tolerance, risk capacity and the other assets available to meet the need. TDF only takes into account the time frame.
5. If you intend to invest in a TDF make sure you understand how it is to be used. Unfortunately there is misconception. Some think that if one TDF is good, having five different dates would be better. That defeats the whole purpose. Others think that if you have the TDF, it guarantees that you can retire at that date without income, which is not true either.
Most individuals would do better seeking proper investment advice than taking a cookie-cutter approach of a TDF. Lacking proper advice use a TDF with care.