Hands-off investing has become de rigueur among America’s youngest workers.
According to Fidelity, those between the ages of 22 and 34 overwhelmingly favor target-date funds for their 401ks, with more than half its clients in this age group investing their entire retirement accounts in these funds.
For those unfamiliar with target-date funds, they automatically adjust the allocation between stocks and bonds as you age (less stocks and more bonds) on your way to retirement.
However, while target-date funds are popular with young adults, they aren’t always the best product to own. Sometimes there are better alternatives, such as balanced funds. So when is a target-date fund worth it?
Why Target-Date Funds Have Exploded
Most young people invest in target-date funds because it takes the investment decision out of their hands. Rather than learning about how to invest a buck, they’re passing it.
I think everyone can at least relate — investing isn’t exactly easy, nor is it always fun.
The federal government has further played into the hands of the financial services industry by making target-date funds a qualified default investment alternative (QDIA). According to pension consultant PlanPilot, the Department of Labor introduced regulations in 2007 that said QDIAs were investment options that a plan sponsor could direct contributions to where a participant hasn’t chosen a specific investment. Further, the rules said QDIAs should be a “product with a mix of investments that takes into account the individual’s age or retirement date.”
That’s essentially the definition of a target-date fund — and business boomed.
A Securities and Exchange Commission report from April of this year stated in its findings: “Roughly 70% of US employers report offering target date funds as their default investment option for company-sponsored defined contribution plans …” Further, Fidelity suggests 84% of plan sponsors offer target-date funds, up from 45% in 2007.
However, just because they’re readily available doesn’t make then the right choice.
When Is a Target-Date Fund Worth It?
There are many reasons why younger people should consider investments other than target-date funds for their 401ks, not the least of which is the simple concept of self-responsibility. No one owes you a safe and secure retirement. Gone are the days of gold-leafed direct benefit pensions. The size of your retirement fund is directly in your control; if you choose a target-date fund opting to let someone else handle the heavy lifting, you can’t be upset when you hit retirement and your nest egg isn’t up to snuff.
It’s like the old saying, “If you don’t vote, you lose the right to complain.”
I believe it’s best to own a target-date fund when you’ve done your homework and understand exactly what you’re getting.
First, there are fees to consider. Morningstar indicates that the asset-weighted average expense ratio for target-date funds was 0.91% in 2012, down from 0.99% in 2011 and 1.04% in 2010. In other words, for every $1,000 you have invested, the fund manager receives $9.10 annually regardless of performance. That’s far more than ETF fees.