Target-Date Funds May Be Riskier Than You Think
If you’ve got a 401(k) plan at work, chances are good that some of your investment options may include something called target-date funds.
A target-date fund is really just a mutual fund that’s designed to create an appropriate allocation of risk and reward based on the date listed on the fund. So a 2030 fund may have a different (presumably less risky) allocation of stocks and bonds than, say, a 2050 fund, as the year 2050 is 30 years away, and 2030 is just ten years away. The idea is that the closer you get to that target date, the more conservative the allocation should become.
But you need to keep in mind that there are risks in every investment, target-date funds included. Even though there’s a date on the fund, that doesn’t mean it offers guarantees of safety. In fact, Morningstar says that back in 2008, funds with a 2000–2010 target date lost an average of 22%! So the actual date means very little—it’s simply the date that the fund is basing its risk and reward model on.
So what are some of the risks of these types of funds?
Well, of course there’s the risk mentioned above. Many people assume that these funds are a safe way to invest for retirement and that they’ll never lose money. And this just isn’t true. It bears repeating that the date listed is merely a guideline that the fund’s management uses to calculate an asset allocation model. It doesn’t mean that all of your money will be there on your target date. And it doesn’t take into account the rest of your portfolio (which may include other stock and bond investments, thus throwing the target-date fund’s allocation out of whack).
Another risk is that it can be very difficult to determine what’s in the funds and how they’ll perform in any given circumstance. Each investment firm has a different asset allocation model based on that date, and these funds can look wildly different across various companies. You need to know what the fund’s actual allocation of stocks, bonds, and cash is before you invest.
And you should know that with most target-date funds, once the target date is reached, the portfolio model stops changing its allocation. So if your fund calls for you to be, say, 80 percent invested in bonds at the target date, it’ll stay that way until you sell the entire fund. This may put your portfolio at risk if interest rates go up. Remember, as we’ve told you before, research tells us that a rising glide path of stocks post-retirement may give you much better results with potentially less risk.
And finally, there are the fees. The average target-date fund had an expense ratio of 62 basis points in 2018. While that’s not terrible, it’s also not great. These fees can really add up over time. And the fees can be even higher for target-date funds that are funds of funds, which usually have hidden fees in the investments they hold. If that’s your concern, then check around for target-date funds with lower fees.
You need to consider all of these risks before you invest in a target-date fund. It doesn’t mean they’re bad; they may work really well for people who want something simple. Just know that even something seemingly simple can turn out to be complicated and expensive.
The information provided should not be considered specific tax, legal, or investment advice and is not specific to any individual’s personal circumstances. To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstances. This material was gathered from sources believed to be reliable, however, its accuracy cannot be guaranteed.
Before investing, carefully consider a target-date fund’s investment objectives, risks, charges, and expenses. To obtain a prospectus or summary prospectus, which contains this and other information, call your financial advisor. Read the prospectus carefully before investing.
Target-date funds are subject to the volatility of the financial markets, including equity and fixed-income investments in the U.S. and abroad, and may be subject to risks associated with investing in high-yield, small-cap, and commodity-related, foreign securities. Principal invested is not guaranteed at any time, including at or after target dates.
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