Drop the Target Date Fund
By: Travis Cruger
If you have all of your 401(k) invested in a target date fund (TDF), you’re not alone. Target date funds are very popular among 401(k) plan participants. According to a study by the Investment Company Institute, 52% of 401(k) participants held target date funds in 2015 . TDF’s are popular because they offer simplicity and automation. However, TDP’s have several disadvantages that can have an extreme impact on your nest egg.
First of all, there shouldn’t be a “one size fits all” when it comes to constructing an investment portfolio. Financial situations and risk tolerances are unique to each investor, and asset allocations should not be determined solely by years until retirement and/or age of the investor.
TDF’s are considered funds of funds, meaning they are funds comprised of several others. The main disadvantage with this is that the expenses are considerably higher. On top of the expense ratio of the TDF you own, each of the underlying funds also have expense ratios to pay for the funds operations and management team. All underlying funds are within the same family, limiting the investor from selecting the best fund for each allocation, across all fund families. This insures that you have a proven management team specialized to the given market sector and asset type.
Your retirement date may be too early to stop growing you’re nest egg. Individuals come to me when they retire and have all of their assets in a target date fund, at or past the target date. This means that it is now at the most conservative asset allocation. However, now the individual doesn’t need the assets right away because the spouse is still working and they want to be invested in the stock market to continue to grow their nest egg. Well, what has your nest egg done for you these past 10-15 years? It has most likely not done much at all because it has been allocated for preservation rather than growth. Furthermore, plan participants have different investment objectives that may not always fit the targeted allocation. For example: two individuals are participants in the same 401k plan, both 10 years from retirement, and 100% invested in the same TDF with the same target date. However, one of them just started saving for retirement and needs more growth then asset protection, while the other has several million dollars built up and is primarily concerned with asset protection.
Asset allocations are much different from one fund family to another. They also may differ in the investment style used; i.e. active vs passive, indexed vs managed funds, etc. With the lack of uniformity, plan participants may experience very different rates of return throughout their career.
Target date funds are also very popular investments held within college savings plans; just as much, if not more than in retirement accounts. The points stated above are relative to college savings plans as well.
If you are unaccustomed to investing and don’t want to take the time to do it yourself, a target date fund may be the right choice for you. Individuals should do their homework and make sure that the target date funds that are offered in their retirement plan are up to par with the industry standard. Consult with a financial advisor if there is any uncertainty.
Doraine Wealth Management Group, Inc. (361) 866-8466Securities and investment advisory services are offered through NEXT Financial Group, Inc., member FINRA/SIPC
Doraine Wealth Management Group, Inc. is not an affiliate of NEXT Financial Group, Inc.
Opinions expressed in this article may not reflect the views or opinions of NEXT Financial.