Retirement Savings Made Easy: The Rise of Target-Date Funds
Simplifying 401(k) Investing
Target-date funds (TDFs) have become the go-to investment choice for many 401(k) participants, capturing nearly 30% of assets in the average 401(k) plan. By 2027, they’re expected to account for roughly 66% of all 401(k) contributions. But what makes them so popular, and are they right for everyone?
The Benefits of TDFs
TDFs offer a convenient, one-stop-shop solution for investors who may not have the time or expertise to manage a custom portfolio. They automatically adjust asset allocation based on an investor’s estimated retirement year, shifting from more aggressive holdings like stocks to more stable ones like bonds and cash. This simplicity has made them a favorite among employers, who often use them as the default investment option for automatically enrolled employees.
Expert Endorsements
Financial experts like Christine Benz, director of personal finance and retirement planning at Morningstar, praise TDFs for taking important investment decisions out of investors’ hands. They provide inexpensive and reasonable investment advice, discouraging behaviors that can erode returns, like buying high and selling low.
But Are TDFs Right for Everyone?
While TDFs have their advantages, they may not be suitable for all investors. Those with ample savings outside their 401(k) plan or who prefer a more hands-on approach may find that TDFs don’t align with their risk profile or investment goals. Asset managers have different investment philosophies, and employers often only offer TDFs from one financial company, which may not align with an investor’s needs.
Understanding Risk and Customization
It’s essential for investors to understand the risk level of their TDF and whether it aligns with their personal risk tolerance. Additionally, TDFs don’t allow for “tax location” of different assets, which can impact after-tax investment returns. Investors may be able to build a less expensive portfolio on their own using a mix of index funds, but this approach requires more effort and expertise.
The Verdict
While TDFs have their limitations, they can be a valuable tool for investors who are new to investing or prefer a more straightforward approach. As Benz notes, “Do target-date funds help investors who are unaware of the basics of investing find their way to a sane investment mix given their life stage? A thousand times yes.”
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