What You Need to Know about Target Date Funds - Rodgers & Associates

What You Need to Know about Target Date Funds

A target date retirement fund is a mutual fund that blends stocks, bonds, and cash equiv­a­lents in its portfolio, creating an asset mix for the investor who will retire in the target date year.

Most often, a target date fund is a mutual fund comprised of other mutual funds covering different parts of the financial market. The blend of invest­ments becomes more conser­v­ative over time, according to the fund’s estab­lished “glide path” as it approaches the target date year.

Target Date Retirement funds were first intro­duced in 1996 by Wells Fargo and Barclays Global Investors as a solution for employer plan partic­i­pants who felt incapable or disin­ter­ested in choosing investment options for their 401k or 403b contri­bu­tions.  Their popularity increased between 2002 and 2003 as T. Rowe Price, Vanguard, and Fidelity intro­duced their own roster of target date funds.

Dollars flowed into these funds, first in response to being an easy solution for the “Do It for Me” investor (as opposed to the “Do It Myself” investor). Secondly, as a result of being selected as a Qualified Default Investment Alter­native (QDIA) by the Department of Labor (DOL). Plan sponsors may invest partic­ipant accounts in a QDIA if plan partic­i­pants do not make an investment choice.  So by default, assets in these types of mutual funds grew.

How Target Date Retirement Funds Drew Resentment

After the market upheaval of 2008 target date retirement funds faced great scrutiny by the combined forces of Congress, the DOL and the SEC in 2009. The 2010 target date funds of Vanguard, Fidelity and T. Rowe Price had just posted 2008 calendar year losses of 20.67%, 25.32%, and 26.71% respec­tively.  These losses were a shock to individuals who were just 2 years shy of retirement.

There has been much delay in the SEC’s regulation of target date funds but it appears that future regulation does not promise changes in the structure of target date funds but more disclosure of that structure, partic­u­larly the asset allocation at the actual target date and a graphic of the glide path. So it’s still every investors’ respon­si­bility to under­stand their investment choice.

Not all target date funds are created equal. If you are consid­ering a target date fund as the sole investment in your employer retirement plan, research very closely the particular target date fund that is available to you.

  • Review the asset allocation of the fund as it is invested now. Is it similar to the asset allocation of your other invest­ments?
  • Inves­tigate the glide path. Most paths now continue to glide past the target date year. For example, Vanguard Target Retirement Funds glide 10 years past the target date; Fidelity Freedom Funds glide 15 years past the target date.
  • Consider fees. There will often be two layers of expense ratios, one for the under­lying mutual funds and one for the target date fund. If the under­lying funds are index funds, the total expense ratio will typically be more modest.

Target date funds are easy for the investor and provide a broadly diver­sified, well-disciplined portfolio whose asset allocation is rebal­anced period­i­cally and adjusted over time.

However, they are not a perfect investment and cannot make up for inade­quate savings or guarantee success. We believe that asset allocation may be the single most important decision in deter­mining your ability to meet your retirement goals. The big question with target date funds is whether they will allow you to meet your individual needs.