When Is a Target-Date Fund Right for You?

Target-date funds are useful, but only if you're ready to find out what you're getting into.

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When Is a Target-Date Fund Right for You?

If your 401k offers a target-date option like the Vanguard Target Retirement Series, which charges an average of 0.15% annually, you know you’re not getting hosed.

Next up is something called “glide path.” No, I’m not veering off into aeronautical science. Rather, it’s the degree to which your target-date fund adjusts the equity component of the holdings each year. There are two types: funds that manage the asset allocation “to” retirement and those that manage the asset allocation “through” retirement.

It’s a complicated subject, to be sure, but what’s most important is that the fund manager isn’t taking his or her foot off the gas too soon. For example, in your 20s it makes sense to own mostly equities because you have plenty of time to recover from market downturns such as what happened in 2008. Look for glide paths that don’t ratchet up the fixed income component too early as you could outlive your retirement savings.

I know in my parents’ situation (my dad died this year at 81; my mom is 79), the fact they kept investing in equities well into their retirement helped with their nest egg. Bonds wouldn’t have cut it over the last three years.

Another important factor in target-date funds is what’s actually held in the fund. You wouldn’t order a pizza without knowing the ingredients; the same holds true for target-date funds.

For instance, in the case of Vanguard Target Retirement 2050 Fund (VFIFX), its asset allocation is 90% equities and 10% bonds. It achieves this by investing in four Vanguard mutual funds including the Vanguard Total Stock Market Index Fund (VTSMX) and Vanguard Total International Stock Index Fund (VGTSX), which account for 63% and 27% of the portfolio, respectively.

The target-date fund’s prospectus states that by 2057, it will be 100% invested in fixed-income securities, which tells us its glide path is “through” retirement and not “to” retirement. 

Bottom Line

I’m a big believer in the KISS method of investing — keep it simple, stupid.

It’s great that young people are saving and investing so early. However, it’s all for naught if you don’t understand your investments from top to bottom. Furthermore, if your company offers a 401k contribution match, make sure you maximize that freebie. Not doing so is equally inept.

So when is a target-date fund worth it?

When you understand how it works and the reasons why you’re investing in it. Until then, you’re playing fast and loose with your hard-earned money.

As of this writing, Will Ashworth did not hold a position in any of the aforementioned securities.


Article printed from InvestorPlace Media, http://investorplace.com/2013/11/target-date-fund-401k/.

©2014 InvestorPlace Media, LLC

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