According to research from the Employee Benefit Research Institute, Target Date Funds are extremely popular among 401k Plan providers and their participants. In 2014, 70% of 401k plans offered target date funds in their pool of investment options and 60% of 401k plan participants in their 20’s were invested in a target date fund. The heightened popularity may be due to potential investors being misled by a target date funds capabilities. If you’re not familiar with what a target date fund or lifestyle fund is, it’s a mutual fund that offers a diversified portfolio and re-balances itself towards being more income focused based on your projected retirement date. For example, if you’re 34 and you plan on retiring in 30 years you’d have a target date fund with an allocation based on a 30-year retirement goal.
Most mutual fund companies offer some type of target date fund because of their large appeal to retirement investors. Fidelity Investments offers the slew of Fidelity Freedom Funds, Vanguard offers the Vanguard Target Retirement Funds, and Blackrock offers the LifePath Target Date Funds. You’ll usually find your retirement year in the mutual fund name such as the Vanguard Target Retirement 2045 Fund because it gives the investor the sense that this fund was created specifically for someone like them that is trying to retire in 2045. One is would assume if they want to retire in 2045 and a mutual fund has 2045 in the name then it must be the right fund to invest in, but one would be assuming wrong.
Like I’ve stated in a previous blog post about 401k target date funds, target date funds aren’t a bad default option for 401k plan investors, and they are almost assuredly better than not investing at all however you can’t take any investment vehicle as a one size fits all. Every investors situation is unique and should be treated as such. Just because you are the same age as another investor doesn’t mean you have the same financial goals or are in the same financial situation as that other investor. Your age is just one variable in the whole strategy of your financial plan. Other variables to consider are the number of dependents you have now and may have in the future, the activities you’d like to partake in during retirement, the possibility that you may retire from one profession but pursue another that you’re more passionate about but pays less, the amount of money you’ve currently saved for retirement, the tax bracket you are currently in, and plenty of other variables.
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If you’re a novice investor, then a target date fund may be a good place to start. They can offer an easy, low cost way to diversify your asset allocation without you having to even know what asset allocation means. They also re-balance themselves without you having to lift a finger if your assets get over weight in one class. But you must remember that target date funds are just one option and they aren’t customized for your specific situation. Using a target date fund as a “set it and forget it” retirement option would be an enormous error on your part. A good strategy to take would be to search the target date funds offered in your 401k investment options and choose one that has a low expense ratio. Use that target date fund as a temporary holding place until you speak with a financial advisor or do a little more research on your own. Once you’ve spoken with your financial advisor or you’ve done your independent research and you’ve figured out just how complex your financial situation is, make your move to investment vehicles that are more customized to fit your needs and goals. Few people have time to choose all of the right investment vehicles for a healthy diversified portfolio so it may be best to let an advisor do it for you. But always remember that no one’s financial situation is static. Our lives change and our circumstances change and there’s no way that a mutual fund manager that you’ve never met is going to be able to customize his investment approach based on your specific circumstances at any point in time. So don’t just assume one size fits all.
Author Bio: Jerry D Mitchell II is the owner, CEO, and Principal Financial Advisor of Incite Wealth Management LLC, a fee only registered investment advisory firm in Orlando, FL. Jerry’s passion is closing the wealth gap by increasing the financial literacy of young professionals and underserved minorities. To connect with Jerry you can follow him on Twitter @The_iAdvisor.