Target-date funds have become a popular way to save for retirement because they are such a simple idea that they qualify as a default investment for employer retirement plans such as 401(k)s. They have advantages, but they also have risk. The big risk is that your risk and return profile is not the same as that of the average person scheduled to retire when you are.
A target-date fund invests in a mix of stocks and bonds that are appropriate for an average person given the chosen retirement date. A fund with a target date of 2015 should be more conservative than one with a target date of 2055, for example, even though the circumstances of any one 64-year-old and any one 24-year-old may be vastly different than those of the average.
That’s the primary issue.
The secondary issue is that the funds don’t always invest the way that they claim to. In the financial crisis of 2008, funds with a target date of 2010 were often heavily invested in equities, not in safer investments, causing problems for those who had hoped to retire in two years. The fact is that the fund managers are trying to beat performance benchmarks, and that’s not always consistent with the investors’ goals.
Related to that is that some target-date funds are managed with the expectation that investors will cash them out when the date arrives, while others assume that investors will keep their money in for the length of retirement. This affects the investment choices and risks the fund managers are willing to take.
All of this would be noise except for one thing: the Department of Labor has ruled that target-date funds are Qualified Default Investment Alternatives, or QDIAs. This means that companies can automatically invest employees’ money in them if the employee does not select an investment in a 401(k) or similar plan.
In most cases, a target-date fund is better than nothing, but it’s not as simple a decision as the promoters would like you to think. The more unusual your personal situation is, the more you should consider something else. A good place to do research on funds is Morningstar, and no, they don’t pay me. They just offer good, objective information.
A target-date fund may work for you. The most important thing is to get in the habit of saving for retirement; once that’s in place, you can optimize the funds in your portfolio.
