Many of you probably have the option to utilize a Target Date Fund (TDF) in your company’s 401k plan. Target date funds are mutual funds or exchange-traded funds structured to grow assets in a way that is optimized for a specific time frame. In a 401k plan that time frame would be retirement. These funds have really grown in popularity over the past 10 to 15 years. In fact, many 401k plans have TDF’s as their Qualified Default Investment Alternatives (QDIA). The Department of Labor recommends plans to offer TDF and other types of QDIA funds within 401k plans.

The purpose of TDF’s is to make investment selections easier for the less-financially sophisticated employee. Having a target timeframe (like 2040) ties the goal to the investment plan for the employee and the fund will automatically become more conservative as that date approaches. However, not all TDF’s are created the same. There are multiple differences in TDF’s allocations, fees, and whether it is a managed or passive investment. For our article today, I am going to only discuss allocation and I will be using a specific 2040 target date as my reference point. The date 2040 means, it should be appropriate for someone that might be retiring in the next 20 years.

Let’s look at the Target Date 2040 funds from each of these companies: Vanguard, Fidelity, American Funds, T. Rowe Price and State Street. From within these companies, the 2040 equity allocations range from 88% to 78% and the fixed income/cash ranges from 22% to 11%. For a person with a 20-year timeframe that could be a big difference in performance and volatility. As we dig deeper into these five companies’ 2040 TDF’s, we find the allocations to US stocks versus international stocks varies tremendously. US stocks represent 49% to 75% of the total equity allocation while International represents 25% to 41% of the total equity allocation. Since US and international equity returns do not move in lockstep with one another, the returns of seemingly similar funds can be quite different.

The point I am trying to make is to pick a TDF based on more than when you think you might retire. Do a bit more research and look into the equity and fixed income allocations the various TDFs in your company’s 401k have and then choose the year based on the allocation that you are most comfortable with. In addition, you should look at the other investment options within your 401k plan. You don’t have to choose just one TDF either or one other investment option. In most cases a combination of target date and other funds could be your best choice. If you have questions with your 401K options, we are here to help you.

Spencer D. Neal, AIF®, C(k)P®

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