IFYF Monthly Investing Messages

Personal Finance September 01, 2016 Print Friendly and PDF

 

 


 

Investing For Your Future Monthly Message

Barbara O’Neill, Extension Specialist in Financial Resource Management

Rutgers Cooperative Extension

oneill@aesop.rutgers.edu

September 2016

 

What You Need to Know About Target Date Funds

Also known as lifecycle funds, target date funds are “all in one” portfolios that typically include three types of investment categories known as asset classes: stocks, bonds, and cash equivalents (e.g., money market funds). Their asset allocation weights (e.g., 50% stock, 30% bonds, 20% cash) automatically adjust and get more conservative (i.e., lower stock percentage) over time without any need for investors to take action.

 

Target date funds (TDFs) typically have a date in their name such as the “2040 Fund” or “2050 Fund” and investors chose a fund with a date that matches, or is close to, their expected year of retirement. Dates are spaced out at 5- or 10-year intervals (e.g., 2030, 2035, etc.), depending on the mutual fund provider.  Most TDFs are “funds of funds” with underlying funds from the same fund family. Examples include Fidelity Freedom Funds, Vanguard Target Retirement Funds, and T.Rowe Price Retirement Funds.

 

TDFs were created in 1994 and have gained popularity in the last decade as a qualified default investment alternative (QDIA) for tax-deferred retirement savings plans such as 401(k)s and, more recently, Thrift Savings Plan (TSP) accounts for new federal employees. Some employees who are enrolled in employer investment plans fail to provide instructions for investing their deposits. In these cases, employers invest their plan contributions in the default investment. Investors also like TDF’s “low maintenance” style for savings outside of workplace plans.

 

Below are some key facts about target date (lifecycle) funds that investors need to know:

 

  • TDFs generally only make sense if they include the bulk of someone’s retirement savings. Otherwise, their asset allocation is altered by “outside” investments, which contradicts the whole premise of using them.

 

  • A defining characteristic of TDFs is their glide path, which determines the asset allocation mix over time. Pictured as a descending staircase, the glide path indicates how the stock percentage decreases over time.

 

  • Glide paths are a critical factor in TDF performance and investment companies use several types of glide path methods. Glide paths are used in both TDFs and age-adjusted portfolios in 529 college savings plans.

 

  • “To” glide path TDFs assume that retirement age is the target date and, at that point, the portfolio’s stock percentage weighting and investment mix remains static. “Through” glide path TDFs continue to decrease the stock percentage for a designated number of years after the target date before leveling off.

 

  • The “landing point” is the point in the glide path where a TDF reaches its lowest stock percentage allocation. Not surprisingly, TDFs with different glide paths and landing points have very different risk profiles.

 

  • TDFs are not without controversy. Performance issues during the financial crisis brought to light the fact that many TDFs were not as conservatively positioned as their names implied. This led to new disclosure rules by the U.S. Securities and Exchange Commission in 2010, including better disclosure of TDF glide paths and portfolio composition.

 

Do you want to know more about TDFs? The Cooperative Extension System held a 90-minute webinar on target date funds in 2015. To view the webinar video archive, visit https://learn.extension.org/events/2030.

 

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