Question: Thoughts on target date retirement funds?

Are you ready for retirement?

What are your feelings on the "Target Date" retirement funds? My husband has several 401(k) accounts at multiple institutions from past jobs, and we'd like to consolidate them into one firm. We have all our other investments in Vanguard, and he has both traditional and Roth IRA accounts there he could roll the 401ks into. At the moment, both are using the Target 2045 funds. Are these types of funds generally fine, or would it be a bad idea to continue putting a bunch of money into them? Amanda, New York

Response:

What is a target date fund? In a retirement savings plan like a 401(k) a target date fund automatically resets the employee’s portfolio according to some preset formula. The basic idea behind target date funds is that younger workers will own a mix of investments heavily weighted toward equities and other riskier assets and, as they age, the investment mix will automatically shifts into more conservative investments.

For example, the Vanguard 2045 (VTIVX) invests in 4 index funds, with approximately 90 percent of assets in equities and 10 percent in bonds. Within 7 years after the target date the fund will be 30 percent stock and 70 percent bonds, Vanguard’s preferred asset allocation for investors in retirement. (One question is how comfortable are you with that kind of asset allocation?) The business is dominated by the mutual fund behemoths Fidelity, Vanguard and T. Rowe Price.

Target date funds are popular. According to the Employee Benefits Research Institute, nearly 4 in 10 of the nearly 24 million participants in its 401(k) database own target-date funds. Target date assets crossed the $500 billion market in the first quarter of 2013, calculates Morningstar. One reason behind their growth is the fund relieves workers of making asset allocation decisions and rebalancing their funds. Another factor is that a target date fund is an acceptable “default” option in a retirement plan. In other words, if you elect to participate in a company’s 401(k) or are automatically enrolled in the plan but aren’t sure where to put the money the company is allowed by law to place your money in a target date fund.

As I said, I think target dates are fine. The problem with them is that you need to look carefully at the fund itself.  The devil is in the design details. For example, these funds may hold more equities than many near retirees may be comfortable with, a realization that hit hard during the 2008 bear market. Fees on these funds vary, and some are quite high. The trend toward adding various asset classes boosts diversification (say, by adding real estate and commodities to the mix) but it also increases complexity and fees. Morningstar offers a wealth of industry data in its Target-Date Series Research Paper, 2013 Survey:  http://corporate.morningstar.com/us/documents/ResearchPapers/2013TargetDate.pdf).

If you like target date funds the Vanguard fund meets all my criteria for a good investment: Low annual fees (0.18 percent a year); good diversification in stocks and bonds, both domestic and international; and a limited number of broad-based index funds.

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