Retirement planning can be a daunting task, especially for those unfamiliar with investment strategies and financial markets. In its most basic form, retirement planning is saving, investing, and risk management, all carefully monitored and adjusted over time. 

In an effort to make retirement planning easier for the average worker, many employers and financial advisors recommend Target Date Funds (TDFs). These investment funds have grown in popularity due to their simplicity, professional supervision, and built-in risk management. 

Let’s take a closer look at Target Date Funds and discuss why they are considered one of the most effective retirement savings tools developed in the past 40 years for the average worker.

WHAT IS A TARGET DATE FUND?

A Target Fate Fund is a mutual fund that is designed to provide investors with a professionally managed investment solution through a diversified portfolio that automatically adjusts risk as the investor approaches retirement.

HOW DO TARGET DATE FUNDS WORK?

Choose a Target Date: When you invest in a TDF, you select a target date that aligns with your expected retirement age (e.g. Target Date 2050 if the individual expects to retire in 25 years). This date determines the fund’s investment strategy. 

Diversified Portfolio: TDFs typically invest in a mix of assets, including stocks, bonds, and sometimes other investments like real estate or commodities. This diversification helps to manage risk and potentially improve returns.

Automatic Rebalancing: As you get closer to your target date, the fund automatically shifts its allocation from riskier assets (stocks) to more conservative ones (bonds and cash equivalents). This gradual adjustment, known as the “glide path,” is designed to protect the accumulated savings from market volatility as retirement draws near. 

Professional Management: TDFs are managed by professional investment teams. These teams continuously monitor market conditions and make adjustments to the fund’s investments to stay on track toward the target date.

Set-It-and-Forget-It: Once you’ve invested in a TDF, you can generally leave it alone. The fund’s automatic rebalancing and professional management take care of the investment decisions.

In Retirement: Even after the target date is reached, the fund continues to adjust its asset allocation to balance the need for income with the preservation of capital, addressing the financial needs during retirement.

SIX KEY BENEFITS OF TARGET DATE FUNDS

1. Simplicity: One of the most significant advantages of TDFs is their simplicity. Investors can select a single fund based on their expected retirement date, and the professional investment managers handle the rest. This simplicity makes TDFs especially effective for those who may not have the time or expertise to manage their investments actively.

2. Professional Management: TDFs are managed by professional fund managers who make investment decisions based on extensive research and market analysis. This professional oversight can provide peace of mind, knowing that experts are handling the complex task of asset allocation and risk management.

3. Diversification: TDFs offer diversification across a range of asset classes, including domestic and international stocks, bonds, and other alternative investments. This diversification de-risks the portfolio as a whole by softening the impact of poor performance in any single asset class.

4. Automatic Rebalancing: The automatic adjustment of the fund’s asset allocation over time means investors don’t need to worry about rebalancing their portfolios. This feature ensures that the investment strategy remains aligned with the participant’s time horizon and risk tolerance.

5. Cost Efficient: Many TDFs have relatively low expense ratios, especially when offered through employer-sponsored retirement plans. Additionally, the all-in-one nature of these funds can reduce the need for multiple transactions, further lowering costs. Building an investment portfolio similar to a TDF would be very difficult to mimic by yourself and costly if you were to hire a professional advisor to do it for you.

6. Fiduciary Protection and Compliance: Employers frequently select Target Date Funds as an investment default for participants that don’t make a selection themselves. In more technical terms, this is called a Qualified Default Investment Alternative (QDIA). Under ERISA regulations, TDF’s can offer a level of fiduciary protection to employees when used as a default investment. The use of TDF’s align with industry standards and best practices.

TARGET DATE CRITICISM?

Despite the benefits we discussed, Target Date Funds face one primary criticism: personalization. Some argue that TDF’s are not personalized and therefore, do not align with individual risk tolerances or retirement goals. Most of this criticism has been promoted by financial advisors who provide personalized investment advice for a fee.

While it is true that Target Date Funds don’t offer one-on-one financial advice, extensive research and behavioral studies highlight TDFs’ ability to overcome common investor biases and deliver consistent returns while still providing a wide range of risk profiles that offer options to those who want to swing for the fences (aggressive) or those who prefer singles and doubles (conservative). 

DOES IT MAKE SENSE FOR PARTICIPANTS?

The answer is yes! Professionally managed Target Date Funds represent a robust, low cost, and user-friendly investment option for those planning for retirement. For most people, the primary goal is to build a secure and sufficient nest egg without having to become an investment expert.

Target date funds align well with this goal by offering a professionally managed and diversified investment option. Target Date Funds simplify the retirement planning process by providing a set-it-and-forget-it solution, thus allowing participants to focus on their day job while their retirement savings continue to compound in the long-term.

IN CLOSING

If you’d like to learn more about professionally managed target date funds, drop us a line. As experts in employer-sponsored retirement plans, we can help craft retirement plan options that are best suited to your workforce.