Is your 401(k) allocated to help achieve your retirement goals?
Most 401(k) and other retirement plans now offer Target Date Funds (TDFs), which are intended to align investment risk with your anticipated retirement date. They have become increasingly popular for a few good reasons but are rarely the best solution once your accounts achieve some size.
Let’s look at how they work and whether they are the most efficient choice for you.
TDFs are a great choice for beginners, or when you join a new employer plan. There is typically a lineup of 10 or more funds in a plan targeting every five years for the next 30 or 40 years. Often, they are funds run by the plan sponsor and are an envelope “funds of funds”. So, this diversifies each payroll contribution to maybe a dozen funds selected to complement each other. The main difference between choices is the percentage of stock funds vs. bond funds, as they all get increasingly conservative as their target date approaches.
Newer plans may even automatically enroll new employees. This helps both the employee and the plan sponsor. Most companies match half of the first 6% of salary you defer into their 401(k), providing extra retirement savings and reducing fees by growing the total plan balance. So, TDFs are the default investment election for participants based on age, which is a big advantage over holding the money in cash.
So, why are TDFs not the greatest thing since sliced bread?
To start, all of your money is invested with one fund family, instead of getting different approaches and methodologies. These funds are also allocated evenly across asset classes and industries instead of tactically selecting investments suited to the current economic environment. They also evenly spread bond exposure instead of actively selecting appropriate issuer qualities and maturities.
The biggest challenge with TDFs is that you don’t want all your investments too conservative as you enter retirement! Yes, you want to make sure that you have some conservative assets to draw on during rough patches, but you need growth because you still have a long-term timeframe for some of the money and you want your income to keep pace with inflation.
Here are a few things to consider:
- How do you make your investment decisions? Is it by looking at last year’s performance?
- Do you actively rebalance your accounts?
- Do you compare what you own against what’s available?
- If you have money in an old employer plan, have you thought about the advantages of an IRA?
- Are you familiar with the concept of layering investment risks to match your goal timeframes?
You should review your 401(k) often as it will fluctuate along with the markets.
Call us to review your investment approach (404) 941-2800.