Target Date Funds Help You Stay the Course and Invest Successfully

Last Updated Aug 31, 2011 6:11 PM EDT

According to a recent study, 401(k) participants who invested in target date funds between 2007 and 2009 were highly likely to remain invested in these funds. The study, recently released by the Employee Benefit Research Institute, shows that 97.2 percent of participants who were auto-enrollees in target date funds in 2007 were still using target date funds in 2008, and 95.7 percent remained invested through 2009. For participants who were not auto-enrollees but still invested in target date funds in 2007, 90 percent of these participants remained invested in target date funds by 2009.

Target date funds are a good way to help you stay invested in the market during market downturns. As I noted in a previous post, 401(k) participants who continued contributing to their 401(k) plans during the 2008-09 downturn and maintained their allocations to equities had significantly larger account balances by June 30, 2011, compared to investors who stopped contributing or reduced their stock exposure during the downturn. The high number of investors noted above most likely have similar results to show for their efforts.

But before you move your retirement savings into your 401(k) plan's target date fund, look under the hood to make sure you're comfortable with the fund's asset allocation. Most target date funds have substantial exposure to equities; as a result, you might experience some volatility during the next few years, even though equities are intended to give you higher returns over the long run, compared to other investments.

Also, don't blindly pick a target date fund based on the fund's target retirement date; you could be more exposed to equities than you'd like. I suggest that you first decide the mix between stocks and bonds that you're comfortable with, then choose the target date fund that currently has that asset allocation.

Target date fund sponsors can have different views on the appropriate asset allocation. To test the water, I looked at the allocation to equities of the target date funds of three popular mutual fund companies: Fidelity Investments, T. Rowe Price, and Vanguard. The graph below shows differing views on the appropriate allocation to equities for three different retirement scenarios: retirement income, a 2020 retirement date, and a 2030 retirement date.

You can usually find the asset allocation for your 401(k) plan's target date funds on the plan adminstrator's website or in the printed material that describes your plan's funds. Don't get discouraged if you can't locate it right away -- with a little persistence, you should be able to find it.

While looking under the hood may take a little extra time and effort, it will be worth it to you over the long run to know exactly what you're investing in. This helps you choose an investment strategy for the long-term, and stay the course when the market tests your patience.

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    Steve Vernon helped large employers design and manage their retirement programs for more than 35 years as a consulting actuary. Now he's a research scholar for the Stanford Center on Longevity, where he helps collect, direct and disseminate research that will improve the financial security of seniors. He's also president of Rest-of-Life Communications, delivers retirement planning workshops and authored Money for Life: Turn Your IRA and 401(k) Into a Lifetime Retirement Paycheck and Recession-Proof Your Retirement Years.