Should You Invest in Target-Date Funds?
November 23, 2015 | Your Finances
When you’re sifting through the options in your retirement plan, target-date funds provide an appealing and convenient option. They offer professional management, rebalance regularly and shift allocation as you move closer to retirement. By pegging retirement asset allocation to a specific retirement date, they eliminate the need to select an entire lineup of funds, which can be time consuming.
More retirement plans are offering target-date funds for precisely those reasons. In 2013, 71 percent of retirement plans offered target-date funds, and 41 percent of all plan participants held assets in target-date funds1. In company-sponsored retirement plans, target-date fund assets have grown from $44 billion in 2004 to $703 billion in 2014, according to the Investment Company Institute.
But there’s no free lunch. While target-date funds offer many positives, they take a one-size-fits-all approach to retirement planning that may not be appropriate for you. Not everyone planning to retire on the same date has the same investing needs. Because of their very nature, target-date funds fall short on providing an individualized solution to meeting your retirement investment objectives.
If target-date funds are an option in your retirement plan, consider not only the differences within target-date funds, but also whether a target-date fund is right for you. As you work through that process, take a look under the hood of any target-date fund you already own or are considering adding to your portfolio. Then, with more information in hand, you can decide whether including a target-date fund in your portfolio is right for you.
Target-Date Fund Variables
While target-date funds are designed to appear simple, many are really quite complex. Here are some of the most important factors you might want to consider when investigating specific target date funds:
1. Approaches to the end target date. Target-date “to” funds reach their most conservative investment asset allocation at the specific retirement date, while target-date “through” funds continue to reduce exposure to more aggressive asset classes for a set number of years after the target date.
2. Glide path. A glide path is the strategy that a target-date fund manager employs to decrease the percentage of riskier assets such as stocks and increase the percentage of conservative investments, such as bonds. Fund managers take different approaches to creating these glide paths.
3. Funds of funds. Companies that offer target-date funds take different approaches to constructing target-date funds, which are essentially funds made up of other mutual funds. Some include only three or four funds, while others include as many as 10 or more. The decision about how many and which funds to include affects ultimate fund performance.
4. Asset allocation. Target-date funds can vary in terms of the percentage of stocks, bonds, cash and other investments they hold. These differences may increase or reduce risk and may or may not correlate with your overall retirement investment objectives.
5. Investment style. There are three target-date investment style options: passive, active and strategies that combine passive and active approaches. Passive strategies are designed to match the performance of a particular market index. The success of active strategies depends on the ability of the manager to select securities. While active strategies offer more opportunity to potentially outperform the market, they can also underperform the market more drastically.
6. Cost. Many variables contribute to the ultimate costs of a specific target-date fund. Costs cut into performance, so the less expensive a target-date fund is, the more of that fund’s performance you keep.
How to Choose the Right Strategy
Target-date funds solve one of the biggest problems that can derail retirement planning by offering a consistent asset allocation that is related to your expected retirement date. However, by ignoring other important variables critical to retirement planning, they can shortchange you.
Target-date funds make the assumption that everyone retiring at the same time should follow the same investing strategy. In reality, that isn’t true—your current financial situation and future retirement goals are likely to be completely different that your neighbor’s, sister-in-law’s or co-worker’s are.
While time horizon is an important consideration in building an investment portfolio that will meet your retirement needs, it’s far from the only factor. Other variables include your risk tolerance, expected life span, other assets and liabilities, and your specific retirement and financial planning goals and objectives.
Additionally, a company-sponsored retirement plan or IRA is just one part of a retirement plan. Retirement planning is a complicated, ongoing endeavor that involves many considerations regarding Social Security, estate planning and more. It’s likely that retirement will be the largest, most complex financial planning goal you will ever encounter. The average 65-year-old will live nearly 20 years after he or she retires2. Saving for a retirement of that duration requires a disciplined commitment and customized investment strategy.
That’s why it can make sense to consult with an experienced financial professional before deciding whether to switch to or add a target-date fund to your retirement investment portfolio. Adding the experienced perspective of someone who understands your situation and goals to the decision about what funds to include in your retirement investment portfolio can result in a portfolio that is aligned with your ultimate retirement objectives.
Northwestern Mutual is the marketing name for The Northwestern Mutual Life Insurance Company (NM), Milwaukee, WI and its subsidiaries. Northwestern Mutual Investment Services, LLC (NMIS) (securities), subsidiary of NM, registered investment adviser, broker-dealer, member FINRA and SIPC. Northwestern Mutual Wealth Management Company® (NMWMC), Milwaukee, WI, (fiduciary and fee-based financial planning) subsidiary of NM and federal savings bank.
Please remember that all investments carry some level of risk, including the potential loss of principal invested. The principal value of the fund(s) is not guaranteed at any time, including at the target date. Past performance is no guarantee of future results. No investment strategy can guarantee a profit or protect against loss.
You should carefully consider the investment objectives, risks, expenses and charges of the investment company before you invest. Your Northwestern Mutual Investment Services Registered Representative can provide you with a prospectus that will contain the information noted above, and other important information that you should read carefully before you invest or send money.