Target-date funds not only are one of the most popular investments in 401(k) plans but also are gaining ground as an option for Main Street investors who essentially want to set their portfolio on autopilot. According to Morningstar, TDFs surpassed the $500 billion mark in the first quarter of 2013, up from $378 billion in 2011 and $71 billion in 2005.
With a few years of track records, performance and analytical research available, experts say TDFs are a decent option for investors. Even though they offer diversification, proper asset allocation and a glide path, however, they don’t necessarily fit every investor perfectly. Even for funds with the same target year, allocations and glide paths (the change in allocation as the target date approaches) can vary dramatically. Those who choose to employ TDFs should first consider their goals, savings rate, risk tolerance and then find a fund with the asset allocation and glide path right for them.
TDFs were originally conceived to serve as simple, one-fund investment plans. In theory, investors simply pick a year closest to their retirement date, select an option and get a complete portfolio that offers the right asset allocation and glide path.
But in practice, Brian Plain, a Certified Financial Planner from Oak Park, Ill., says the prospect of a TDF is all about what’s under the hood. Glide paths and allocations can vary tremendously among funds of the same year.
Another problem with TDFs is that they focus solely on the date and fail to factor in the individual characteristics of the investor, Plain says. For example, two 35-year-olds may be selecting a 2040 fund. The funds may have similar allocations and glide paths but could have different outcomes if one investor is just starting and another has $200,000.
“I think you should be starting with where you stand, what your goals are then select the fund that is right for you,” Plain says. “A target-date fund doesn’t always take into account the individual situation.”