Target-date funds are the cruise control of retirement investing. All you have to do is pick a fund and the fund manager makes all the decisions about how much to allocate to stocks, bonds, and cash throughout your entire lifetime. Some retirement savers don’t even need to actively pick the fund. Target-date funds are one of the most popular 401(k) default investments that employees are automatically enrolled in unless they specifically opt out.
But it’s a good idea to take a closer look at the underlying investments in a target-date fund. The Labor Department and Securities and Exchange Commission released target-date fund guidance for investors last week. The publication highlights the significant differences among target-date funds in how they invest and reallocate assets over the life of the fund. Here are five questions to ask about your target-date fund.
What is my target retirement date?
Target-date funds that have the same retirement year in their name may have very different investment strategies. The Labor Departments cautions that you should not rely solely on the date you wish to retire when choosing a fund or deciding to remain invested in a target-date fund. Instead, consider the fund’s current asset allocation and how it changes over time. Even if you plan to retire in 2030, a 2020 or 2040 fund may be more in line with you investment objectives.
How will the investment mix change over time?
Target-date funds contain a mix of investments that grow more conservative as you approach the date in the fund’s title. But not all funds shift into less risky investments at the same rate. While some target-date funds reach their most conservative investment mix near the target retirement date, others may not reach their most conservative point until decades after the target date. For example, one target date fund might hold 60 percent of its investments in stocks at the target date, which gradually decreases until 25 years after the target date when it reaches 30 percent in stocks. Another target-date fund might invest 25 percent of the fund in stocks at the target date and decrease that amount to 20 percent five years later. The fund's prospectus will generally explain the transition the fund manager plans to follow. But the fine print can change after you begin investing in the fund. “The fund manager can make changes in the future without your approval – even if those changes will create more risk,” says the Labor Department. “You should monitor your target date fund’s investments over time.”
How much does it cost?
Similarly named target-date funds may charge different amounts of fees. If a target-date fund invests in other mutual funds, fees may be charged by both the target-date fund and the other funds. “A fund with high costs must perform better than a low-cost fund to generate the same returns for you,” the Labor Department says. “Even small differences in fees can translate into large differences in returns over time.”
What is my overall risk tolerance?
Don’t assume that a target-date fund has the appropriate amount of equity exposure for your age. Make sure the target-date fund has a level of risk you are comfortable taking on. Also, consider the underlying investments including allocations to developing and emerging international markets, U.S. stocks, bonds, and cash. If you have other investments outside your target-date fund, examine your overall asset allocation to make sure the target-date fund fits appropriately into it.
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Will I be able to retire on my target retirement date?
Whether or not you will be able to retire on the date named on your target date fund depends on how much you save, how the investment performs leading up to retirement and after you retire, and what your expenses are in retirement. Target-date funds do not guarantee that you will have sufficient retirement income at the target date. Investors can lose money and many people did in 2008.