Target Date Funds: 401k’s Most Popular Investment Choice
The popularity of target date funds has grown substantially over the past 10 years. Currently more than 50% of 401(k) investors have all their assets in target date funds. Not all this popularity is investor driven. Instead, much of this growth is structural. Currently just over 50% of target date funds are with companies that have their own record keeping, but these companies control over 80% of the assets under management. This, coupled with the fact that they are the default choice for most 401k participants, has led that growth. Here are some important things to understand about target date funds:
Age Based, Glide Path
The first thing to understand about target date funds is that they are an age-based approach that uses a “glide path” to adjusting the allocation. Investors are placed into a target date fund based on age (at the plan level) and consequently an estimation is made for a future retirement date. For example, say you were put in the Vanguard Target Retirement 2050 Fund. Most likely you were born in the mid 1980’s and the fund assumes you have a future retirement date of 2050. Then the fund adjusts its allocation accordingly as you approach that assumed retirement age.
One major benefit of target date funds is that they keep investors disciplined. Investors that make emotional decisions tend to make them at the wrong time, leading to potential problems in their long-term financial health. Target date funds allow the investor to stay invested, but at the same time lower portfolio risk as they get closer to retirement. They do this by decreasing their exposure to stocks and replacing that with bonds.
The target date approach is a comprehensive philosophy. Its common belief is that as you get closer to retirement, you should be taking less risk with your investments. This is because as you approach retirement many cannot afford the increased volatility. This approach of “glide path” or continually lowering your exposure to stocks as you age, embodies this idea. The hang up with this as a comprehensive approach is that people have assets, expenses, and investments outside their 401k. For this reason, there needs to be coordination and planning holistically to make sure that this approach makes sense.
Same Concept, Different Investments
While the concept of target date funds is standard, the investments do vary among products. Funds will differ in their underlying holdings. For example, Vanguard holds all their passive securities and Capital Group holds all their actively managed American Funds. They will also differ in timing of when they re-allocate the portfolio, assumptions about timing of retirement, and allocation within each asset class. These funds may sound the same, but underneath the hood they are different.
Target date funds provide a solid standardized solution for your average 401k participant. It gets them invested and follows a disciplined concept that aims to keep them invested. Here at THOR, we also have a disciplined strategy but our approach is more detailed in asset allocation and portfolio construction.. We tailor portfolios based on an individual’s specific risk profile and financial situation. We then tactically manage our asset allocation depending on the opportunities in the market and provide thoughtful due diligence on each investment. If you have questions about your target date fund or financial situation, please contact us!