Should You Trust Your Retirement to a Target Date Fund?

As the name suggests, target date funds have a target date, such as 2020 or 2040, for retirement. While most comprise mutual funds, they can also be exchange-traded funds. TDFs are growing in popularity, and many 401(k) plans now offer them as an option. However, despite their name, they're no guarantee that you'll have all the money you need for retirement. Before investing in a TDF, carefully weigh the pros and the cons based on your specific situation.

How They Work

Target date funds are a combination of funds designed to automatically reset the mix of stocks, bonds and cash equivalents in its portfolio so that it matures on a selected date in the future, such as your retirement. For example, if you plan to retire in 2038, you might choose a fund close to your retirement date like 2040. Typically, funds start out more aggressive, investing a larger portion in stocks, and then shift to more bonds as they near their maturity date. Once you invest in a TDF, the investment company makes all the decisions regarding how much to hold in each category -- stocks, bonds, etc. -- as well as when to move from an aggressive or growth stance to a more conservative one.

Pros

Target date funds' biggest pro is their "set it and forget it" nature: The investment company does all of the heavy lifting throughout the life of the investment. They decide what and when to buy or sell something, as well as when to rebalance the portfolio. This is a plus for investors who can’t or don’t want to make these decisions for themselves.

Cons

Because the process of investing in a TDF is so simple, it’s easy to get lulled into a false sense of security. Like any investment, you must do your due diligence to determine if it's a good fit for you. However, this is a lot more difficult to do with TDFs because they're a combination of funds. A look at TDFs that are maturing now can help you determine their overall performance, and comparison with other TDFs maturing on the same date as yours can help you evaluate how it stacks up. Some funds will be more aggressive or conservative than others, based on the manager.

Other Considerations

Before trusting your retirement to a TDF, determine the amount you plan to invest. This is one of the biggest determiners of whether you will have enough money in retirement. Check to see if the investment fits with your financial goals, risk tolerance and other factors. As mentioned earlier, some funds are more aggressive or conservative than others, so this could affect your overall return -- and your ability to sleep at night. Determine if the TDF is a good fit with your other investments. Depending on the TDF, it could leave you too heavily invested in one area and/or lacking in another. Finally, take a look at the expenses. TDFs can be more expensive than other funds because they contain a combination of funds and may also include a management fee. Always understand the costs and what you're getting for your money because it will impact your bottom line.