Target Date Funds Don't Suit All Investors
Are you one of the millions of Americans who have invested some of their 401(k) plan money in target date funds? If so, perhaps you should take a closer look at what is inside the fund.
That’s the conclusion of Ron Surz, a pension consultant and long-time critic of these funds, because of the risks they present to those in or close to retirement. He calls target date funds “a bomb waiting to be detonated by the next market correction.”
The concept of target date funds has long been appealing to 401(k) plan participants: Just choose your presumed year of retirement and let the “pros” decide how much money you should have in stocks vs. bonds, and which categories of stocks should be included. This system is supposed to give peace of mind, despite the ups and downs of the markets.
In fact, many companies use target date funds as the “default” option when employees sign up for the 401(k) plan, calling them a safe and efficient way for inexperienced investors to build a retirement account. As a result, there is now more than $3 trillion of retirement money invested in target date funds.
Here’s how they work:
In a target date fund, the percentage mix of stock and bond exposure changes to become supposedly more conservative as you near retirement. But not all target date funds have the same allocation percentages.
For example, in funds for target retirement year 2025, the investment mix may range from 60/40 stocks/bonds to a larger or lesser percentage of stock exposure. It all depends on the judgment of the money management firm sponsoring the fund.
Surz notes the federal Thrift Savings Plan uses target date funds with no more than 30% in risky assets at retirement, compared to the 401(k) plan offerings of major mutual fund companies with higher stock exposure.
Another concern: Most target date funds are designed to get you to retirement — but not through it. That fixed allocation percentage at your retirement date will stay the same for the rest of your life.
We will only know in hindsight which fund’s model was better. But the real concern is that with a high exposure to stocks, a bear market early in someone’s retirement could wipe out enough assets to impact their ability to withdraw enough money over their remaining lifetime.