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.