// 401(k): Should You Be In A Target Date Fund? //
By: Taylor Haney
If you’re reading this, there’s a pretty good chance you’re invested in a Target Date Fund (TDF) in your 401(k) at work. TDFs have become the “go-to” Qualified Default Investment Alternative for the majority of workplace retirement plans. But, is this the best option for you?
What is a Target Date Fund?
A Target Date Fund is a mutual fund or collective trust fund commonly available for retirement accounts that aims to provide a diverse asset allocation that becomes more conservative over time. The TDF serves as a “set and forget” strategy for many retirement savers.
Example: TDF 2050 is designed for an individual who plans to retire in 2050 or is between the ages of 29-33. The further out the “target” retirement date, the more equity exposure or risk a portfolio will typically have.
What is a Qualified Default Investment Alternative?
A QDIA is a provision available to retirement plan sponsors that relives fiduciary liability for investment losses. This typically occurs when a participant fails to select investment options when entering a plan. The Department of Labor has deemed Target Date Funds as a QDIA.
Example: A new employee enters a 401(k) plan at work and fails to select investment options during the enrollment process. This individual is 40 years old. Assuming proper disclosures have been delivered, the plan sponsor can direct employees contribution to a Target Date Fund appropriate for the participant’s age – in this case, Target Date 2040.
The most recent research indicates that more than half of all 401(k) participants are invested in TDFs. I’d really like to know how many of those participants either knowingly picked the TDF or were defaulted into it. Now that we know what a Target Date Fund is and how you likely invested into one, it’s important to understand whether it’s the best option for you.
1) TDFs are generally well diversified portfolios. Trying to replicate the allocation of a TDF on your own could be difficult.
2) TDFs shift to a more conservative portfolio as you get closer to retirement; this could potentially lower your risk at a time when you will need to access the funds.
3) TDFs can serve as a “set and forget” strategy.
4) For employers, TDFs work as a QDIA.
1) TDFs generally have higher fees in the form of expense ratios.
2) The allocation of the TDF may not align with your personal risk tolerance.
- Imagine a young investor who is conservative. If he/she was invested in a TDF appropriate for his/her age, the fund may carry significantly more risk than the investor can handle.
3) Other options may perform better.
4) Not all TDFs are created equal. TDFs amongst various managers (Fidelity, Vanguard, Blackrock) can vary greatly in the makeup of the portfolio – increasing or reducing the overall risk.
So, is a Target Date Fund the best option for you? In the absence of other quality options and professional advice, a TDF could potentially be a good option for you. But, if you have access to other quality options or are willing to work with an investment professional, you may be able to construct a portfolio that more aligns with your personal risk tolerance, time horizon, and goals.
Far too many American savers are not paying attention to their 401(k). This concerns me. Research indicates 93% of participants never adjust their portfolio for risk or market conditions (Quantitative Analysis of Investor Behavior Dalbar Inc., 2016). Why is this? Participants lack guidance from their plan sponsor and the advisors the sponsors hire. This is why so many participants have defaulted into TDFs and have misconceptions about how these funds should perform.
If you are willing to do a little work or hire a professional, then there is likely a better option for you than the Target Date Fund. Unfortunately, some plan sponsors only offer TDFs – I believe this is a tragedy. For those that offer a diversified fund lineup, you should consult a financial planner or investment professional for guidance. Many advisors will charge a one-time consulting fee to have a risk analysis, investment analysis, and retirement projection analysis completed to help you determine which investments are appropriate for you. If you are looking for ongoing investment management, some plan sponsors offer a discretionary managed account solution, but I am not a huge fan of those (that topic is a future blog post).
For many of you, I believe a TDF may not be your best option. For some of you, it may be your only option. If you are currently invested in a TDF and are unsure of whether or not it makes sense for you, please reach out to us and we’d be happy to work with you. Here at Visionary Horizons, we offer Active401k as an on-going, non-discretionary investment advice solution. You can learn more about Active401k here.
All the best,