Target Date Mutual Funds. The answer for your 401k or IRA?
Target date mutual funds by all accounts seem simple. Determine the year in which you want to retire and put a bull's-eye on the calendar. Go to your employer-sponsored 401(k) or IRA, or to your individual brokerage account, and find the target date mutual funds that match your retirement date. Start pouring your retirement dollars into that one fund.
As the years go by, your fund is routinely rebalanced and becomes incrementally more conservative. The theory is that as your retirement date arrives, the changing asset mix will provide the proper recipe for stability and growth.
Target date mutual funds can help eliminate the confusion many employees and investors feel when faced with too many mutual fund choices in the typical 401(k). Each fund is a mix of cash, bonds and stocks, including in many cases some foreign stocks. The fund's name includes the retirement year, and the funds are usually spaced five years apart (e.g., 2010, 2015, 2020, etc.).
Pros of target date mutual funds:
Target date mutual funds bypass minimum investments - Most mutual funds have a minimum investment (usually a few grand) to buy into the fund. If you try to buy into various funds individually to create a well diversified portfolio, you will need a substantial amount of cash. For target date mutual funds, you only pay this minimum investment once.
Automatic investments - It doesn’t matter how much self control or investment knowledge you have. You automatically get a desireable asset allocation that shifts with time. Along with that desired asset allocation comes a certain amount of reassurance that you won’t lose your entire nest egg.
Target date mutual funds cons:
Subpar performance - Investment firms will undoubtedly look out for their own interests. Therefore, firms like Vanguard or T Rowe Price will only include their companies funds (stock/bond/investment/emerging market) in their target retirement funds. Therefore, you may lose out on performance. Surely, that company does not have the best mutual funds in every single market.
Lack of control - The selling point of target date mutual funds is that you don’t have to own anything besides it. But at the same time, you shouldn’t own anything besides it (or you will throw off the asset allocation. That means apart from that one fund, you have zero control in your retirement assets.
Target date mutual funds fees - This is the same argument between mutual funds vs index funds. Sure you’re paying someone to manage the fund, but can you get the same or better performance from owning the market (index fund)
Too often, employees don't use target date mutual funds properly, and you have to wonder whether one fund can really be appropriate for everyone who retires in a given year.
Another potential problem is that employees aren't given enough information regarding the philosophy behind target date funds and how they should invest their money.
While that problem might be fixed by better educating employees and other investors who consider these funds, another situation might be more perplexing to consumers. The asset allocation in a specific target date fund can vary from one firm to another.
As with any investment, target date mutual funds can be a good tool for some investors when planning for retirement. However, one must be very aware of the potential drawbacks associated with the funds. Bottom line: There is no cookie cutter approach for every investors needs.
