WHAT ARE TARGET DATE FUNDS?
- Jake Buckwalter
- Sep 2, 2022
- 3 min read
The Basics of Target Date Funds
If you have a retirement plan through work (401(k), 403(b), etc) and are putting money into it, it’s very likely that you currently have money in a target date fund or have at least seen them on your list of fund options. More often than not when doing the initial enrollment through your HR department or online, the default selection is to put everything into a target date fund that corresponds with your anticipated retirement age. Sounds pretty good right? When do I turn 65? Great, put everything into the target fund that most closely matches that age. These options have become increasingly popular. According to CNBC, it is estimated that $1.8 trillion dollars are currently invested in target date funds, and 80% of all 401k participants are in these funds. But is that really the best way to invest? First let’s break down what exactly these investments are made of.
What is a Target Date Fund made of?
A target date fund is like an onion, layers on layers of investments underneath the surface. When you put your money into a target date fund you get a little bit of everything. The breakdown of a 2040 fund from one of the largest investment providers looks like this, and keep in mind this is for someone retiring in 18 years.
45% US stock
42% International stock
10% bonds and 2.38% cash.
Performance of Target Date Funds vs All Index Portfolio
Diversification is a good thing and this is diversified. But how does this compare to other types of portfolios such as one that Dave Ramsey would recommend? Well, as you probably know, the market has had a bad year, currently, the S&P 500 is down 17.55% YTD. So, what did this target date fund do? It is down 17.56% YTD. The 10% exposure to bonds is part of the portfolio for downside protection and even with that, it has underperformed an all-stock portfolio. Given the underperformance in the International markets, it is easy to see why there would be some variation in return. So, I decided to compare the target date fund with an all-index portfolio 25% growth, 25% growth and income, 25% aggressive growth, and 25% international. I used all index options for each category. The results in the chart attached to this article show an initial investment of $10,000 into each option 10 years ago.
The blue line that says ‘benchmark’ represents the specific target date fund that I referred to previously and red line that says ‘portfolio’ represents the all-index portfolio also mentioned previously.
The difference in returns over the last 10 years was 11.5% for the all-index portfolio vs 9.08% for the Target Date fund. In final market value terms $29,716 for the all-index portfolio and $23,856 for the target date fund.
Target date funds have another quality that makes them a unique product. These prebuilt investment vehicles make no attempt to conform to the risk tolerance of the individual investor. Some investors have no problem with market volatility, others lose sleep over market downturns. Unfortunately, if you are in a target date fund, you don’t have the option to remove or add risk to the portfolio. You get what is packaged into the specific fund that you choose. Having a portfolio that matches your risk tolerance can have a huge impact on reaching your retirement goals. It prevents investors from jumping ship when markets get volatile.
What are Target Date funds good for? Can your Advisor manage your 401(k)?
To clarify, I do not hate target date funds. They are a great way to set it and forget it. If you do not have the expertise and/or the desire to research and rebalance your portfolio on an ongoing basis, they do all of that for you. Studies have shown that individuals who use target date funds outperform those who try to do it themselves over time on average. However, If you are interested in making changes to your 401(k) portfolio and find it to be overwhelming, the Financial Advisors at Whitaker-Myers Wealth Managers can help. We offer 401(k) management where we can look at what options you have available in your 401(k) and help you make informed investment decisions that match your risk tolerance and goals. For most individuals, the 401(k) is their primary investment vehicle, which means how you are invested can make or break your retirement. If you have any questions about your 401(k) investment options, please reach out to your advisor today.