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Target-date funds are a way for 401(k) participants to automatically manage their retirement savings and account for the majority of an investor’s contributions to a 401(k) plan.
According to the Plan Sponsor Council of America, an industry group, about 29% of the average 401(k) plan’s assets will be held in TDFs by 2023. This percentage is the highest of any fund category and is up from 16% in 2014, according to PSCA data.
By 2027, target-date funds will collect about 66% of all 401(k) contributions and about 46% of total 401(k) assets, according to 2023 estimates from market research firm Cerulli Associates. It is expected to be TDF.
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Its popularity is largely due to the widespread adoption of TDFs by employers as the default investment for workers who are automatically enrolled in the company’s 401(k) plan.
Financial advisers say the fund is a boon for many investors, but could be a boon for others.
“Targeted funds have a place for some investors, but never It’s not going to be available to everyone, nor should it be.” Advisory Council.
How target date funds work
Financial experts generally recommend that investors de-risk their nest eggs as they age. This is typically done by moving from more aggressive and volatile holdings such as stocks to more stable holdings such as bonds and cash.
TDF does this automatically based on the investor’s estimated retirement year.
For example, a 35-year-old investor who expects to retire in 30 years would be more likely to choose a 2055 fund. A 55-year-old might choose a 2035 fund. Funding is typically provided in five-year terms.
The fund’s asset allocation becomes progressively more conservative in the years leading up to, and possibly after, your retirement year.
A one-stop shop for 401(k) savers
Proponents often praise TDF’s simplicity, known as a one-stop shop for 401(k) savers who don’t have the time or knowledge to properly manage a custom portfolio.
“From my perspective, target-date funds are simply the biggest positive development for investors since index funds,” Kristin Benz, director of personal finance and retirement planning at Morningstar, wrote in June. .
They take key decisions such as asset allocation and investment selection “completely out of the hands of investors,” Benz wrote.
She wrote that TDFs provide inexpensive, rational investment advice for people who can’t afford an advisor and are prone to making “unorthodox” investment choices. He added that TDF also discourages actions that harm investors’ returns, such as buying high and selling low.
“It’s designed to make managing your investments easier for those looking for simplicity and convenience,” Sun said.
There may be some drawbacks
But advisors say there are several reasons why TDFs may not work for certain investors, especially those who have sufficient savings outside of 401(k) plans or who prefer a more hands-on approach. said.
First, just because investors expect to retire at roughly the same age doesn’t mean the same asset allocation is appropriate for each of them.
“What if you’re more conservative, or you want more growth, or you want more aggressive technology investments, or you prefer investing in socially responsible investments?” Sun said.
From my perspective, target-date funds are nothing short of the biggest positive development for investors since index funds.
Christine Benz
Director of Personal Finance and Retirement Planning, Morningstar
Asset management companies have different investment philosophies. For example, certain fund families may be more aggressive or conservative than others.
Employers typically only offer TDF from one financial company, and the funds provided may or may not match the investor’s risk profile, experts said.
Carolyn McClanahan, a certified financial planner and founder of Life Planning Partners in Jacksonville, Fla., says, “People need to understand how much risk they’re taking with target-date funds. is important,” he says.
“For example, you’d think a fund with a 2030 target date would be conservatively allocated, but most are 60% stocks because they expect to draw down the money over a long period of time,” CNBC says. McClanahan said. Advisory Council.
Investors may be able to build a cheaper portfolio on their own by using a mix of index funds, but this approach will require more effort on their part, he said.
Additionally, TDF does not allow for “tax location” of various assets, McClanahan said.
It aims to increase after-tax investment returns through strategically holding stocks and bonds in specific account types.
For example, assets with high growth potential are good candidates for Roth accounts because investment earnings are generally tax-free in retirement, McClanahan said.
Experts generally recommend holding most bonds and bond funds in tax-deferred or tax-free accounts.
Despite their drawbacks for certain investors, “target-date funds can help investors who don’t know the basics of investing find a path to a healthy investment mix that takes their life stage into account.” Will it help?” Benz wrote. “A thousand times yes.”
