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In today’s blog, we are going to discuss an investment vehicle that many people who have an employer sponsored retirement plan may be exposed to but might not necessarily understand. And those are called target date funds.
Now, the reason we find this review of incredible importance is that many workplace retirement plans typically automatically default one’s contributions into one of these investment options if they don’t choose to allocate their contributions in another way.
On the surface, you may read descriptions about how target date funds shift you from a more growth-oriented allocation to a more conservative allocation automatically as you near retirement.
Somewhat of an all-in-one design where with a single investment selection, you delegate the work of diversification, rebalancing, and adjusting risk over time.
Instead of juggling multiple funds or tracking changing market conditions, the idea is you just pick the year closest to when you expect to retire and let the fund do the rest.
But the fact is, understanding the details of your actual fund could potentially make a significant impact in your outcome.
At their core, many target-date funds are structured as fund-of-funds, meaning they hold a mix of other mutual funds or exchange-traded funds inside the single fund wrapper.
The “date” in the name reflects your intended retirement year, and the fund manager oversees how the mix shifts over time.
For example, in the year 2025, a 2060 fund typically starts more aggressive with heavier allocations to stock, then gradually tilts toward bonds and cash as retirement approaches.
But not all of these funds are the same, despite the fact that they may have the same date within the name of fund.
Each provider chooses a different balance of underlying holdings, so two funds with the same retirement year label could end up producing very different results.
In addition to this, the cost check can also be important, because a target-date fund can carry multiple layers of fees.
In many cases, there’s the expense ratio associated with the target-date fund itself, plus the costs of the underlying securities it holds.
But for savers, particularly those who might not want to be involved in the day-to-day management of their retirement plan or maybe don’t have a financial advisor to help them work through customized options, this convenience can be real.
Now the structure guiding the adjustments over time is typically referred to as the glide path.
It defines how the portfolio over time might reduce exposure to stocks or assets seen as more risky as your retirement date nears.
On paper, this could reasonably be seen like a balanced trade-off: maximize growth when you can afford risk earlier in your career, then working towards preserving capital at a time when you might want or need more stability.
But that assumes the same glide path works for everyone, which may not be the case.
You can think of a target-date fund like a prepackaged meal prep kit.
You may save time, you don’t worry about the grocery shopping, and the ingredients all show up in the right amounts. But you don’t typically get to customize beyond what’s in the box.
The principle thought is similar here where a target-date fund’s decisions on risk and allocation are essentially pre-determined, and you follow them whether they fit your exact needs or not.
Let’s take a look at where this might come into play- Two investors in different 2040 funds may unknowingly take on very different levels of equity exposure.
One could be in a portfolio that’s still 80% stocks, while another is closer to 65%.
On statements, both see “Target Retirement 2040,” but the actual risk their accounts carry in this instance, is certainly not identical.
And this is more than just a minor detail; as it could potentially have a direct impact on your risk and growth potential.
An aggressive allocation could offer more growth potential but could also come with a higher chance of a steep decline during market downturns.
Conversely, a conservative allocation might feel safer, but it may not keep pace with inflation over decades, eroding your purchasing power.
This brings up a critical concept: sequence-of-returns risk which is the risk of experiencing poor market returns right when you begin taking withdrawals.
Generally speaking, Target Date Funds follow a "to" retirement or a "through" retirement path.
A "to" fund typically reaches its most conservative allocation at the actual target date. It assumes that is the date you will be retiring and that stability is now a top priority.
A "through" fund on the other hand assumes you will in theory hold the fund for years after retirement so it may continue to adjust allocations well into your 70s or 80s, staying more growth-oriented for a longer period.
This difference has could have significant implications where an investor in a 2025 "to" fund may be focused on preservation, while someone in a 2025 "through" fund might still have half their portfolio in stocks.
As we dive further into our client’s options, understanding the fees associated are always at the top of our minds.
And while it may be easy to overlook fees in a target date fund, they could significantly impact your long-term returns.
As stated earlier, many target date funds are "funds of funds," meaning they don't hold individual stocks or bonds directly.
Instead, they invest in multiple underlying funds which each come with their own expense ratio.
In addition to those underlying funds, the target date fund itself then adds its own management fee on top of that.
This layering can add additional complexity when it comes to analyzing the overall fees of a particular investment options.
At their core, target-date funds essentially ask you to pay for convenience and automation.
For some investors, that cost might be worth it, particularly if they know they otherwise wouldn’t manage rebalancing or allocation shifts on their own or with the help of a financial professional.
But for others, the potential for heightened fees and inefficiencies might not be the best route.
The bottom line is this: layers of costs, the difference between active and passive structures, and the tax treatment of where the funds are held can all have tangible effects on one’s outcome.
Target-date funds can be a useful solution, but not everyone benefits equally from their structure so let’s walk through the situations where they might make sense, and where they could fall short.
They might make sense if you’re looking for a low-effort, single-solution approach.
These funds in theory are built to spare you from actively rebalancing or constantly checking whether you’re holding the right mix of stocks and bonds.
They could also potentially work well if you have a straightforward retirement plan with a clear date in mind, such as retiring around 65, and don’t expect to deviate far from that timeline.
In addition, there is the potential of adding behavioral value.
Target-date funds might help reduce that temptation to change your allocations during market swings by keeping things on autopilot. This could in turn help savers stick with their plan over the course of various market cycles.
On the other hand, target-date funds don’t always fit well for more complex situations.
If you plan to retire much earlier than traditional retirement ages or expect to work well into your 70s, the preset glide path may not match your needs.
These funds can also pose challenges if you have multiple account types and want to use more tax-efficient strategies.
That degree of precision isn’t always possible when everything is bundled together.
Similarly, if you’re comfortable managing your own asset allocation—or want a custom glide path that reflects your personal view of risk—you might find the standardized approach too restrictive.
The Final Word:
Now, we are not saying target date funds are either good or bad with this blog. We do however want people to understand what they may be invested in within their employer sponsored retirement plan.
As always, we suggest speaking with your trusted financial professional to see if these funds may be right for your particular situation.
Thanks for reading!
Disclaimer:
Rockline Wealth Management (RWM) is a registered investment adviser located in Islip Terrace, NY. RWM is registered with the U.S. Securities and Exchange Commission. Registration of an investment adviser does not imply any specific level of skill or training and does not constitute an endorsement of the firm by the Commission.
Rockline Wealth Management does not offer tax or legal services. The information in this material is not intended as tax or legal advice. Please consult legal or tax professionals for specific information regarding your individual situation.
All information presented is believed to be factual at the date of publication. This blog should not be viewed as advice for any individual and is intended for general informational purposes only.
All investment strategies have the potential for profit or loss. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment or strategy will be suitable or profitable for a client's investment portfolio.
Asset allocation and diversification do not ensure or guarantee better performance and cannot eliminate the risk of investment losses. The opinions expressed and material provided are for general information and should not be considered a solicitation of financial advice or for the purchase or sale of any security.
Real-life and fictional examples given in this blog should not be viewed as guaranteed outcomes when investing. Past performance is not indicative of future results and every individual’s investment circumstances are different. Individuals should consult their financial professional before implementing their investment plan.
Certain information contained herein constitutes “forward-looking statements,” which can be identified by the use of forward-looking terminology such as “may,” “will,” “should,” “expect,” “anticipate,” “project,” “estimate,” “intend,” “continue,” or “believe,” or the negatives thereof or other variations thereon or comparable terminology. Due to various risks and uncertainties, actual events, results or actual performance may differ materially from those reflected or contemplated in such forward-looking statements. Nothing contained herein may be relied upon as a guarantee, promise, assurance or a representation as to the future.