If you contribute to a 401(k) or 403(b), then odds are you have the option to invest in what are called Target Date Funds (TDFs). TDFs are diversified investments that become more conservative over time. Typically, the closer the date the more conservative they are. They started to appear in the 1990’s and as of today there are about $2 trillion invested in these funds. However, there can be significant differences between TDFs with the same date, so due diligence is required. If you believe you will retire in 2030, you should not just blindly select a TDF with the same year.
When we examine a specific target date, let’s say 2030, we start to see the significant differences. For example, of all the 2030 TDFs available some have as little as 19% in bonds and some as much as 52%. The differences in types of stocks can be wide as well. Some 2030 TDFs have barely any international equity exposure while some have as much as 34%. And if you are looking for income from the investment be sure to examine the fund’s current yield. Some in the 2030 category are as high as 5% while some are below 1%.
Because of these differences, it should not come as a surprise that performance will vary as well. Volatility also will show in different levels. Among 2030 funds, standard deviation was between 7% and 14%. This means that one fund was twice as volatile as another, and they both have the same label! The problem with TDFs is that they give the illusion that asset allocation is simple. Knowing which year you are to retire is one of many factors to determining how much risk you should be taking on with your investments. Others include your expenses, fixed income, and risk tolerance. None of which are taken into consideration with TDFs. Those concepts are best addressed in a personalized setting with a financial planner.
Investments in target date or target retirement funds are subject to the risks of their underlying holdings. The year in the fund name refers to the approximate year (the target date) when an investor in the fund would retire and leave the workforce. The fund will gradually shift its emphasis from more aggressive investments to more conservative investments based on its respective target date. The performance of an investment in a target date or target retirement fund is not guaranteed at any time, including on or after the target date, and investors may incur a loss. Target date and target retirement funds are based on an estimated retirement age of approximately 65. Investors who choose to retire earlier or later than the target date may wish to consider a fund with an asset allocation more appropriate to their time horizon and risk tolerance.