What They Don't Tell You About Target Date Funds and Your 401(k) Plan
- Bob Brooks
- Sep 30
- 2 min read
According to Vanguard Mutual Fund Company, 68% of 401(k) participants are invested in Target Date Funds. 68% is a concerning amount of participants investing in target date funds. They are also referred to as lifestyle funds or freedom funds with other companies.
Why is this so alarming?
It starts with the marketing pitch. It is “easy”. You don’t have to do anything. Let the fund managers make changes things for you. It is one of the best ways to easily retire. As a result, investors are drawn to the marketing pitch and choose them in their 401(k) plan. Well, they forgot to tell you everything.
What are target date funds?
These are mutual funds that are selected based on your year of retirement. For example, if you planned to retire in 2010, you would invest in the 2010 Target Date Fund. The idea is that every year as you get closer to retirement in 2010, the fund is mandated to take less risk because you’re approaching retirement. In theory, by the time you retire in 2010, you are taking a minimal level of risk because you are in retirement.
On paper, it sounds like a great strategy. Here is an example using Fidelity Freedom Funds (uses the same concept): Say you are retiring in 2010. For the last 10 years you have been invested in the Target Date 2010 plan. Returns looked strong during the bull market – until the financial crisis of 2008 happened. Most investors assume Target Date funds will protect them from risk. Of course, that is what a Target Date Fund or Freedom Fund is designed to do – reduce risk along the way.
Back to the 2010 fund – If you are planning to start retirement next year in 2010, and a bear market happened, you would feel pretty safe because you were in a 2010 fund. With your retirement coming up within the next year, you would think that the 2010 fund would protect your nest egg. Let’s take a look at the performance of a 2010 Fidelity Freedom Fund.
According to Morningstar, the overall total return of the Fidelity Freedom 2010 fund was –22.82% from November 2007 to March 2009. Does that look like the fund of 2010 lived up to its objective? Did they protect you as you’re going to enter retirement?
Do yourself a favor and make sure you are comfortable with the details about these funds because you might be taking more risk than you want. The problem comes down to emotion. Everyone reacts differently to periods of big losses. Telling a prospective client that you will retire and everything will work out great might be a stretch of the truth. This is about setting appropriate emotional expectations. The last thing you want to do is make an emotionally charged decision about changing something after taking a big loss.
Bob Brooks
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