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Should You Bother with Target Date Funds
Anymore?
The recent market shock should remind all investors that
there's no such thing as a single solution investment product
that works for everyone. One particular category of investments
that became a target of scorn is target date funds, which are
mutual funds with investments tailored to the particular
retirement date of the account holder.
According to U.S. News and World Report, funds that were
designated for individuals retiring in 2010 lost an average of
25 percent of their value in 2008, obviously rewriting the
retirement plans of millions who mainly held these funds in
their 401(k) plans. Despite the fact that these supposedly
diversified investments are supposed to shift most assets into
conservative investments as the individual gets closer to
retirement, critics have said managers still keep too much stock
in these funds near the end.
Over the decade, money has been gushing into these funds,
according to the Investment Company Institute. By year end 2006,
this fund category held $114.3 billion in assets, up from $12.3
billion in 2001. By the end of 2008, that number had receded to
$109 billion. Why the demand? The whole "check it and
forget it" mentality made target funds a natural choice for
individuals who didn't want to actively manage their own 401(k)
accounts at work. Also, the Pension Protection Act of 2006 gave
employers the right to put 401(k) participants in target funds
as the "default" choice if the employees don't make
their own selection.
Ibbotson Associates reported in July that after an industry
average of six quarterly losses, target date funds finally
posted a solid gain at the end of the second quarter. So does
that mean it's time to go back on autopilot again?
It might be a better idea to take a thorough look at your
finances. A visit to a CERTIFIED FINANCIAL PLANNER™
professional should be the first step in determining whether
target funds — or other investments — should be part of your
retirement rebuilding effort. For instance, some critics say
life-expectancy issues are not adequately addressed in
target-date plans, and they definitely don't address scenarios
in which you plan to work in retirement or spend your assets in
unconventional ways. Also, some critics say that many people may
underfund such plans without realizing the correct amounts they
should invest to meet their goal. A planner's job is to advise
individuals on an ongoing basis about meeting such goals.
That said, how should you evaluate a target-date fund? Here
are some questions you should ask:
Do you know how much money you'll need to retire? A
successful retirement is not all about the retirement date. It's
about the quality and activities you'll prefer in retirement and
how much it will cost to afford them. It is one thing to invest
in a fund that promises consistent growth until a scheduled
retirement date, but what if you need more growth? What if there
are specific tax and spending issues that might interfere with
putting the right amount of money into such funds each year?
This is why individual advice makes sense.
What about the target funds your employer has selected?
Obviously, most employers want to make the right fund choices
for employees, but just because they're offering target funds
doesn't mean they're offering the right target funds for you and
your needs. Keep in mind that most fund choices offered to
companies are heavily marketed and might not be the cheapest or
most efficient investment choices out there. Always check the
Morningstar rating of any fund your 401(k) invests in.
Morningstar is a major ratings agency for mutual funds. It's
wise to check the performance of all the funds within your
company retirement accounts.
What if you leave your job and take your 401(k) with you?
What happens to your targeted investment plan then? You can roll
over these assets into another tax-advantaged retirement plan,
but what will happen to your annual retirement savings strategy
at that point?
What are you paying for a targeted fund? Granted, the
investment choices are being made for you, but what are you
paying for those choices? Often, these funds are constructed
based on a fund-of-funds structure that layers a fee on top of
the fees incurred by the individual funds. Always understand the
fee structure of any fund you invest in.
September 2009 — This column is produced by the Financial
Planning Association, the membership organization for the
financial planning community, and is provided by Don McCarty of
Financial Decision Partners, a local member of the FPA.
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