Target Date Funds: Why you need to review your 401k plan.

We get asked during most prospective client meetings

“Will you review my 401k plan?” - Yes. Of course.

We examine everyone’s employer-sponsored plans to ensure they are invested properly relative to their unique situation, goals, and objectives.

What we regularly find is startling.

When you first joined the company and it comes time to set up your 401(k) account, you likely weren’t sure which funds to choose on your own so you let the computer do it for you. You casually picked a date out into the future that sounded good for retirement. 2020, 2025, whatever it was. You probably didn’t give it much thought.

Based on this date the 401(k) provider, or more specifically the automated software, since there isn’t an individual making a personal selection for you, chose one single fund, to cover all your needs, based on the date you told the system.

And at the time, you set up the account you may or may not have even noticed which fund was selected. You clicked through until it said, “done” and went back to focusing on your brand new job.

This single investment is known as a Target Date Fund.

And for many years there was really nothing wrong with this fund. You saved automatically, invested the money, and the fund seemed to be doing just fine.

But year after year past. You’re getting closer and closer to retirement. Maybe even still working past the date you originally told the system, and here’s where things start to go sideways regarding your plans for retirement.

Inherently, there is nothing wrong with target date funds.

However, a Target Date Fund is no different from any other investment; it can easily be misunderstood and misused when you don’t review your investments.

Wait, what is a target date fund?

It’s the thing in your account that says,

“Target Retirement 2030” or “Target Retirement 2025” or worse

“Target Retirement 2020”. Huh?

2020?

Let’s take one quick step back to explain a target date fund and what to look out for.

A Target Date Fund groups mutual funds together for the investor, like a mutual fund groups stocks together.

We call this a “Fund of Funds”. The Target Date Fund assembles multiple mutual funds together for you, the investor, essentially creating a portfolio for you within one single fund.

The Target Date Fund creates the portfolio primarily based on the length of time you have until the retirement. The further away the date, the more risk.

In this context the fund defines risk as the relationship between stocks and bonds. The further away the more stocks (equities).

If you are going to retire next year, you will have lots of bonds, and few equities. If you are going to retire in thirty years you will have lots of equities and few bonds.

So Mutual Fund = a basket of stocks in one place.

Then we have a fund made up of Mutual Funds called a “Fund of Funds”.

A Fund of Funds = a basket of FUNDS in one place.

A Fund of Funds is a type of “Done-For-You” portfolio.

ABC Company Target Date 20XX Fund might look like this…

• Large Cap U.S. Stock Fund 30%

• Small Cap U.S. Stock Fund 20%

• International Developed Markets Fund 20%

• Emerging Markets Fund 10%

• Bond Fund 30%

These positions add up to 100%, and now you have a Done-For-You 70/30 portfolio.

70% Equities(stocks) and 30% Bonds.

Viola!

A Target Date Fund = a basket of funds grouped together specifically based on the relationship between risk and time until retirement. The more TIME you have until retirement, the more “risk” you can afford to take.

This follows the belief that if things in the market go south, you have enough time to recover; therefore, you can afford to take more risk.

So if you started today and told the system you were going to retire in 2030. The system would have you invested in lets say 70% stock mutual funds and 30% bond mutual funds.

If you told the system you were going to retire in 2050, you’d be invested 90% stock mutual funds and 10% bond mutual funds.

Now we know what a Target Retirement Fund is, here’s how it works.

Let’s say back in 2005 you told the system you were going to retire in 2020; the Target Retirement 2020 fund starts out at 80% equities (stocks) and 20% bonds. As time goes on, the company running this fund will reduce the risk (reduce the equities) for you and adding more bonds as you get closer to the year 2020.

The company running the fund does it for you.

It’s like having your own personal advisor managing your money and looking out for your best interest!

Unfortunately not. And many people get this confused.

The problem is, it’s 2024, and you’re still working (four years later). Even if you did retire tomorrow, you may not need to touch the money in your 401k, and meanwhile, the money you save every paycheck is being invested as if this account is your only hope of survival. It's ultra-conservative and not growing as it should be. Since there isn’t anyone actually looking out for your best interest at the 401(k) plan company, no one ever said anything.

For the last four years, you’ve been saving into the 401k plan, thinking you are doing the right thing, and unknowingly buying mostly bonds while the stock markets’ been on a tear.

This hurts. Your portfolio hasn’t grown anywhere near the rate you needed it to.

Before you say I wouldn’t let that happen to me, check your account and make sure the fund you’re invested in aligns with your risk tolerance and time horizon, not for “retirement” but for actually using the money.

Many of our client's don’t touch their 401k money until they are mandated by the government to take RMDs (required minimum distributions).

If you retire at age 62, you’ve got over 10 years until RMDs kick in!

So you’re investment risk, based on these funds, should align with this timeline, not the date You plan to walk out the door.

Here’s what You should do to prevent this from happening to you (or fix it if it’s already happening).

Log into your 401k plan. Somewhere on the main page their will be a button or menu options that says “Investments” or “Manage Investments” or “Investments Summary”.

Once you arrive on that page, somewhere it will tell you which fund you are invested in.

If you are in a Target Date Fund, somewhere it will say

“Fidelity/Vanguard/etc. Target Retirement 20XX Fund”

Click on the fund to view information about the fund.

Here you will find the relationship between stocks and bonds.

It will say something like 50% stocks 50% bonds. Or 70% stocks 30% bonds.

Ultimately, the right fund and or stocks to bonds ratio is different for everyone.

Maybe you are going to retire tomorrow, but won’t need to touch the money

Maybe you will retire tomorrow and need to access the funds immediately.

Either way, we recommend working with a professional team to make your unique plan.

-Rob

Securities offered through LPL Financial, Member FINRA/ SIPC. Investment advice offered through IHT Wealth Management, a registered investment advisor. IHT Wealth Management and AutomotiveWealth are separate entities from LPL Financial.

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