Most 401(k) plans these days include one or more "target date" funds. Typically, these funds shift to a more conservative asset allocation over time as they approach a specified "target date."
The idea is to provide one-stop shopping for investors who don't want to devote time and energy to managing their retirement portfolios on their own. Pick a fund with a target date close to your planned retirement date, put your money in, and you're done -- at least, that's the promise.
But is it really that simple? What are the pros and cons?
Why some investors need target-date funds In theory, the pros are obvious: A target-date fund is an easy way to get people invested with the "right" asset allocation.
Talk to any 401(k) plan administrator, and they'll tell you that one of their biggest challenges is getting their participants to take the right actions -- from enrolling in the plan in the first place, to investing enough to collect any matching funds offered by their employer, to choosing appropriate investments.
Even companies with highly educated workforces have plenty of employees who can't be bothered to enroll in the retirement plan, who have signed up but don't contribute much, or who have all their money in a money market fund that pays almost no interest. On the other extreme, there are participants who are too aggressive, leaving all their money in volatile investments even as they approach retirement. A market downturn at the wrong time could leave them short of the funds they were counting on.
Target-date funds are designed for all of those cases. Target-date funds like Fidelity's Freedom Funds and Vanguard's Target Retirement Funds make it simple to invest for retirement. All you need to know is your estimated retirement date.
The Fidelity and Vanguard products both invest in a portfolio of other mutual funds, moving from a moderately aggressive asset allocation to a more conservative one as the target date approaches.
It's a good idea -- and for those 401(k) participants who aren't willing or able to take a more active role in their investments, a target-date fund from a reputable firm is far better than nothing.
But what about the rest of us? What are the drawbacks of target-date funds?
Why other investors should look elsewhere For one thing, investors' needs and risk tolerances vary widely, and a one-size-fits-all solution will never work as well as a plan that's custom-tailored to your own needs and circumstances. People who are knowledgeable about investing generally find "off-the-shelf" products like target-date funds to be more conservative than they'd like.
For instance, almost 30% of the assets in Fidelity Freedom 2025 Fund are invested in bond and money market funds right now -- even though the fund's "retirement" date is still a decade away. Many seasoned individual investors would rather wait a few more years before starting to move their assets out of stock funds.
Fees can also be an issue, as the funds that make up the portfolios of target-date funds are often more costly than the cheap index funds that many investors choose. Fidelity Freedom 2035 Fund has a total expense ratio of 0.75% -- not bad for what it is, but a lot higher than the 0.1% charged by the most expensive class of Fidelity's Spartan 500 Index Fund.
The Foolish takeaway: Do some research first Target-date funds may have been designed as "no-brainer" options, but it's still worth doing some research before you choose one. If you're looking at an option in your workplace savings plan, look closely at how the fees and long-term performance stack up against other options.
Long story short, putting your retirement money in a well-structured target-date fund from a good firm is a much better option than doing nothing at all. It's never a truly bad move. But for an investor who is wiling to put in some time and effort a few times a year, there are usually better -- or at least better-fitting -- options.
The article Target-Date Funds: The Pros and Cons originally appeared on Fool.com.
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