On Target Date Funds

As much as I hate to delve into politics, in the last decade or so there has been a really cool new trend that makes 401(k) savings much more understandable, especially for those not in the industry. Legislation has moved towards making 401(k) saving less complicated and more streamlined to encourage participation in 401(k) Plans.

When you take a look at the investment options in your employer’s 401(k) Plan, there are probably a lot of words an numbers that can be confusing. Vanguard Financials EFT? Fidelity Contrafund? Franklin Small Cap Growth? Now, I could spend the next 2,000 words on what these mean and why they are different and why any of it actually matters. The underlying investments that make up those mutual funds are wildly different. But instead, for the next 400 words or so, I’d like to focus on the point of this article, Target Date Funds.

Target Date Funds (TDFs from here on out) make choosing an investment in your Plan easy. All you need to remember is one number. The year you are “projected” to retire, which is typically 65 (check the fund’s prospectus for more detail, let me know if you need help with where to find that). Most TDFs you will see will be something like “Vanguard Target Retirement 2050.” They are typically in five year increments, and are designed for you to choose the one that is closest to the year you will reach normal retirement age, or 65.

Let’s say, for example’s sake, you are going to turn 65 in 2049. The “Vanguard Target Retirement 2050” would be the fund that you would choose. The best part about these funds is that you can operate under the “set it and forget it” mindset. This is because, unlike choosing individual mutual funds, the TDFs AUTOMATICALLY reallocate the underlying investments based on a concept called glide path.

Glide path means that your investment needs are much different as a 35 year old with 30 full years, at minimum, to retirement, than the investment needs of a 60 year old. Every TDF allocation is a bit different, but big picture, the 2050 fund mentioned above will be heavily allocated towards more risky equities now (while still holding some “safe” investments as well), but as we move towards 2050, the fund will change without any action on your part towards safer bond and cash funds. You can survive a market downturn at 35, but at 62? Not as much. Thus, we get the term “glide path” as the fund “glides” from one allocation to the next as the years progress. Theoretically, this allows you to take advantage of market swings at younger ages while shielding you against the huge risk of losing a large amount of your portfolio once you achieve a certain age (think 2008 financial crisis).

As I mention often, I’m not your financial advisor, so you should definitely consult with whomever you run your financial decisions by, but these can be a great tool if you are new to investing, or simply don’t want to do the research into every fund offered in your Plan.