Financial

What You Should Know About Your Target Date Fund

It’s the first week of a new job. Amidst the excitement of taking on a new role and meeting coworkers, your HR manager sends you a pile of paperwork to fill out—W2s, health benefits enrollment, the employee handbook. As if you weren’t overwhelmed enough already, among that stack is your 401(k) enrollment form and a list of investments which to choose from. Decision fatigue leads many people to the default option: a target date fund.

Once the new job craziness dies down, you may start to wonder: what is my retirement account actually invested in, and is it right for me? To determine whether a target date fund is a good fit, there are a few key points to understand:

What is a target date fund?

A target date fund is a type of mutual fund that is designed to match the risk of your investments with your timeline for retirement. They are made up of a split of stocks (aggressive investments) and bonds (conservative investments). When you are 20, 30, or 40 years from retirement, the primary goal for your retirement investments is growth, but as you near retirement age, the goal shifts from growth to wealth preservation. 

A target date fund is the easiest way to follow that path of aggressive investments when you are young and conservative investments when you are close to retirement age. With a target date fund, you can avoid two potentially disastrous investment mistakes: 1) not being risky enough when you are young and far from retirement, and 2) being too risky when you are close to retirement age. It’s designed to start out with an aggressive split of stocks and bonds which becomes more conservative as the fund approaches its “target date.”

What you need to know about your target date fund

How much are the fees? 

The fees associated with target dates funds tend to be slightly higher than if you were to choose your own mix of stocks and bonds. Fees for the target date funds from low-cost brokerages like Vanguard, Fidelity, and Charles Schwab can be as low as 0.08%. But watch out, it’s not unusual to see fees for 401(k) target date funds as high as 1%. These higher investment fees can eat into your returns by tens of thousands (or even hundreds of thousands) over the lifetime of your investments. 

What does the glide path look like?

A target date fund glide path is essentially a plan for how your asset allocation with change over time. By looking at the glide path, you can see what your asset allocation (i.e. your split of stocks and bonds) will be in 2030, 2040, and 2050. 

One of the downsides of a target date fund is that it may start to become conservative more quickly than is ideal. We recommend that if retirement is more than 10 years away, your retirement account should consist of about 90% stocks and 10% bonds. But, for example, according to Vanguard’s glide path, their target date funds drop below 90% stocks once the fund is 25 years out from its target date.

You can get around this by choosing a target date fund that matches the asset allocation you’re looking for, rather than your “target” retirement year. This means that you might need to switch to a different target date fund every 5-10 years earlier in your career.

Final Thoughts

A target date fund typically makes a good default option if you are early on in your career, but to optimize your retirement for the long run, make sure that you understand the fund’s fees and glide path. 

If you need help understanding your retirement investments, talk to one of our Trainers on Demand



Source
What You Should Know About Your Target Date Fund is written by Kylie Lipinski, A Certified Financial Trainer for financialgym.com

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