Many individuals investing on their own are now using target-date funds in their 401ks.
Target-date funds generally have an asset allocation (stocks, bonds and cash) based on your expected retirement date with the expectation that risk is lowered as you age.
More often than not, when we first meet with clients, it is becoming more common to see the majority of their 401k assets invested in target-date funds.
While these types of funds can be a serviceable choice for those starting out or investing on their own, we have discussed the limitations that we see with these funds in the past.
The Recipe of Your Target-Date Funds
We came across a recent article, which discusses what the date in the fund name actually means and how investment strategies are being managed as a result. Not all fund companies have a goal to decrease the risk in the portfolio by the target-date. Some including the bigger names, Fidelity, Vanguard and T. Rowe Price, maintain riskier allocations through the target-date resulting in some being more aggressive than others.
Many investors use these funds when they are not able to devote attention to their retirement savings on a regular basis. But more research is being revealed about the performance of the average investor as it relates to fund returns. Morningstar’s research in particular shows the average investor underperformed the stated returns of their funds by 2.5% per year over the last 10 years. This is primarily due to emotional movements at extremes in the markets.
Is Your Process On Target?
Having a defined process that helps to manage your urges to move in the wrong direction takes discipline. This is one of the cornerstones of our process. It’s equally important to be diligent and consistent with research on the investments you are using in your strategy. Regular attention and analysis allows you to have a better understanding of how a fund invests and the potential upside and downside in different market cycles.
Specific fund choices are important, but before making these decisions, it’s important to determine the risk you need to take within your investment strategy to accomplish the things you want to do. This works best when it’s coordinated with all your accounts taking advantage of your best options in each account.
A financial advisor can help you answer questions about your investment strategy. Specifically if target-date funds are right for you.
