Target date investing can make it easier to fund your future paycheck
by the Editors of Kiplinger’s Personal Finance
Choosing investments can seem complicated, but it doesn’t have to be. As you’re exploring savings options that can help you build a retirement nest egg, consider taking a fresh look at target date funds. Why? New research shows these wildly popular investment funds are so far serving investors well by encouraging prudent savings habits.
First, some background
These types of mutual funds are a one-step, low-maintenance strategy for retirement investing. Here’s how they work: You choose a fund by the year that’s closest to the year you plan to retire. For example, if you’re 32 today and want to retire at 67, you’d pick a 2050 fund.
Then, you invest your money and the fund does all the work. Fund managers decide how much to hold in stocks and bonds, and they automatically adjust the mix to a more conservative blend as your retirement age (the target date) approaches.
The trend: They’re everywhere
These fairly effortless ways to save have been a huge hit among younger investors and employers alike. In fact, 93% of large and midsize employers surveyed recently by Willis Towers Watson use target date funds as their workplace retirement plan’s default investment option—up from 86% in 2014 and 64% in 2009.
As a result, target date funds’ assets have swelled dramatically—the funds held nearly $1.2 trillion in assets as of Jan. 31, 2018, a roughly sixfold increase from a decade ago, according to the latest tally by Morningstar.
The performance test
By design, target date funds are meant to be the only investment in your retirement portfolio. Holding other funds defeats the purpose.
Given that sole focus, it’s fair to wonder whether these popular funds are actually performing as intended. Recently, Morningstar crunched the numbers for every single target date fund from March 1994 to January 2018.
The verdict? On balance, investors have succeeded in using target date funds as they’re intended. Because they tinker less with asset allocation or fund selection, target date fund investors appear to be focusing more on contributing consistently. And that behavior leads to fewer, risky buy-sell decisions that may disrupt gains over time.
The consistency has allowed investors to capture more of target date funds’ total returns over the span that Morningstar studied, says Jeffrey Ptak, global director of manager research.
The ‘glide path’
Like any other fund, target date funds aren’t risk-free and may experience significant losses. And that’s a concern for many investors given recent stock market volatility.
They’re also not all created equal: Each fund takes its own route and timetable for moving into more conservative holdings—known as the “glide path.” The point is that even though all target date funds reduce investment risk over time, each fund has its own strategy for how and when to do that.
For example, some funds are designed to reach their most conservative asset mix at or shortly after the target date, after which they stop making adjustments. These are known as “to” funds. Others may reach their most conservative asset mix 10, 20, or more years after the target date. These are called “through” funds.
What’s more, after reaching their target dates, some funds will then merge into different funds, typically focused on generating income. That’s why it’s important to fully evaluate the glide path of the fund you’re considering. You’ll want to ensure that the asset strategies match your own risk tolerance and retirement timeline.
Looking for more information about different ways to jumpstart retirement savings?
A new guide from The Investor Protection Trust (IPT) and Investor Protection Institute (IPI) called Starting to Save for Retirement, takes inspiration from the groundbreaking public television documentary and community engagement program When I’m 65. It outlines four action steps younger workers can take now to begin creating a more secure tomorrow.
You can also check out When I’m 65 videos with a multigenerational approach on financial management, planning for retirement, and protecting your assets.