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Target-date funding is a way for 401(k) participants to put their retirement savings Autonomous driving – them Occupy the lion’s share Investor contributions to 401(k) plans.
On average, about 29% of assets in 401(k) plans were held in TDFs as of 2023, according to the American Council of Plan Sponsors, a trade group. This share is the largest of all fund categories, up from 16% in 2014, according to PSCA data.
By 2027, target-date funds will account for about 66% of all 401(k) contributions, while about 46% of total 401(k) assets will belong to TDFs, according to 2023 estimates from market research firm Cerulli Associates.
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This popularity is largely due to the widespread adoption by employers of TDFs as default investments for workers automatically enrolled in company 401(k) plans.
Financial advisors say that while these funds offer benefits to many investors, they can have drawbacks for others.
“Target funds are suitable for some investors, but they certainly are not and should not be suitable for everyone,” said CNBC member Winnie Sun, managing partner at Sun Group Wealth Partners in Irvine, California. financial advisory committee.
How Target Date Funds Work
Financial experts often advise investors to de-risk their nest egg as they age—often by moving away from more aggressive and volatile assets like stocks and toward more stable assets like bonds and cash.
TDF does this automatically based on the investor’s expected retirement year.
For example, a 35-year-old investor who expects to retire in 30 years might choose the 2055 fund. A 55-year-old might choose the 2035 fund. These funds are typically released in five-year increments.
Before (and sometimes even after) the retirement year, the fund’s asset allocation slowly becomes more conservative.
One-stop service for 401(k) savers
Proponents often praise the simplicity of TDF, which is billed as a one-stop shop for 401(k) savers who may not have the time or knowledge to adequately manage a customized portfolio.
“From my perspective, target-date funds are certainly the biggest positive development for investors since index funds,” said Christine Benz, director of personal finance and retirement planning at Morningstar. wrote June.
Important decisions such as their asset allocation and investment choices are “completely out of investors’ hands,” Bentz wrote.
She writes that TDFs amount to cheap and sound investment advice for people who may not be able to hire an advisor and may be prone to making “bizarre” investment choices. She added that TDF could also deter behavior known to erode investor returns, such as buying high and selling low.
“They are designed to make it easier to manage investments for those who just like simplicity and convenience,” Sun said.
There may be disadvantages
However, advisors say that for some reasons, TDFs may not be suitable for some investors, especially those with substantial savings outside of a 401(k) plan or who want to take a more hands-on approach.
For one, just because investors expect to retire at the same age doesn’t mean the same asset allocation is appropriate for each of them.
“What if you’re more conservative, or prefer more growth, aggressive tech investing, or prefer to invest in socially responsible investments?” Sun said.
In my opinion, target date funds are undoubtedly the biggest positive development for investors since index funds.
Christine Benz
Director, Personal Finance and Retirement Planning, Morningstar
Asset managers have different investment philosophies. For example, some fund families may be more aggressive or conservative than others.
Experts say employers often offer TDFs from just one financial company, and the funds provided may or may not match the investor’s risk profile.
“It’s important that a person understands how much risk they are taking on in a target-date fund,” says Carolyn McClanahan, a certified financial planner and founder of Life Planning Partners in Jacksonville, Fla. .
CNBC member McClanahan said: “For example, you might think that the allocation of 2030 target date funds would be conservative, but most are 60% stocks because they think you will withdraw these funds over a long period of time. “Advisory Board.
Investors may be able to build cheaper portfolios on their own by mixing in index funds, she said, although this approach requires more effort on the part of the investor.
Additionally, McClanahan said the TDF does not allow for “tax locations” for different assets.
This move aims to increase after-tax investment returns through the following methods Strategic holdings of stocks and bonds In some account types.
For example, McClanahan says assets with high growth potential are well suited for Roth accounts because investment earnings in retirement are typically tax-free.
Experts also generally recommend holding large amounts of bonds and bond funds in tax-deferred or tax-free accounts.
Despite the shortcomings for some investors, “can target-date funds help investors who don’t understand the basics of investing find a smart portfolio for their stage of life?” Bence writes. “A thousand times yes.”
