Why inexperienced investors should consider target date funds

Aug 13, 2018

The popular approach offers ‘hands-off’ investing for retirement, according to Jeff Witz, CFP, and David Zemon.

 

 

 

 

I noticed there are a lot of target date funds listed in my 401(k) investment options. Can you explain how these types of funds work and whether they are worth using in my retirement account?

Target date funds have become quite popular, and many physicians have them as available investment options in their employer-sponsored retirement accounts such as their 401(k)s and 403(b)s. The first target date fund was introduced in 1994 in response to retirement plan participants’ relative lack of knowledge about investing and how to approach managing their retirement accounts. Fund companies wanted to provide participants with basically a hands-off approach to investing for their retirement.

A target date fund works in a relatively simple way. They often reference the target date in retirement, so they may includeTarget Retirement Date 2040 or Target Retirement Date 2050. Investors simply select the fund that correlates to the approximate year they will retire. The funds are professionally managed and start an investor off in an aggressive growth portfolio. As years go by, the fund manager incrementally reduces the risk of the fund by slowly making it more conservative.

As the investor approaches retirement age, the fund is significantly invested in a more conservative allocation designed to preserve the investment gains made during the lifetime of the fund. Depending on which fund company your retirement plan uses, once the target date is reached, the fund will either continue to invest your assets and slowly make them even more conservative, or it will transfer your assets into a separate asset preservation fund with a fixed equity-to-bond ratio.

Also see: Take advantage of compounding interest when saving for retirement

There are advantages and disadvantages to using target date funds. These funds are particularly advantageous for someone who has little or no experience investing. It takes most of the responsibility for investing for retirement out of the individual’s hands and puts it in the hands of a professional fund manager. For individuals not comfortable choosing their investments or not knowing when it’s appropriate to change to a more conservative allocation, these funds are excellent options.

The disadvantage of using a target date fund is that you hand off control of your retirement investing to another decision maker. Depending on your unique circumstances, the decisions made by the fund manager may not fit your investments needs. They may make the fund too conservative too soon or keep it too aggressive too long. This can result in required rate of return objectives not being met.

For more experienced investors or investors who work with an adviser, a better strategy may be to avoid target date funds and create their own retirement investment portfolios by selecting a combination of non-target date funds available in the retirement plan. This allows investors to remain in control and adjust the plan as their rate of return objectives and risk tolerance change, as well as create a portfolio more in line with their unique circumstances.

Whether a target date fund is appropriate for your retirement account really depends on your comfort level in managing your own retirement assets. Target date funds were created for investors with little or no knowledge of investing. It is a great option for some. More experienced investors may want to remain in greater control of their investments and utilize other options available through their retirement plans.

Next:Do tariffs affect the markets?

I’ve been hearing a lot recently about tariffs. Can you explain what they are and why the markets have been reacting negatively to them?

A tariff is simply a tax or duty to be paid on a particular class of imports or exports. For example, President Trump recently announced a 25% tariff on roughly 1,100 Chinese imports. That significantly increases the cost of trying to sell these goods on U.S. soil. The United States has a long history of using tariffs, and the tariffs themselves are not wholly responsible for the increased stock market volatility. Mainly, the tariffs have created uncertainty. There is concern that if the U.S. implements tariffs on China or Europe that they will retaliate with tariffs on U.S. goods.

Read: Donor-advised funds offer several advantages for charitable giving

This environment could make things unpredictable, and the markets hate unpredictability. Therefore, we have seen greater swings in the market and a general retreat from previous market highs.

Send your questions about estate planning, retirement, and investing to Jeff Witz, CFP, and David Zemon c/o Urology Times, at UT@advanstar.com Questions of general interest will be chosen for publication. The information in this column is designed to be authoritative. The publisher is not engaged in rendering legal, investment, or tax advice.