Target-Date Mutual Funds: Are They Still Right for You?
The popular target-date mutual funds shocked investors after the 2008 market crash. People close to retirement saw a quarter or more of their savings wash away, in funds they mistakenly thought were "safe."
I consider these funds terrific choices for retirement savings and, by all accounts, so do you. They're still the most popular funds in 401(k)s. But you have to be smart about using them, and your company has to offer funds that make sense. Some employers make stupid choices and you're stuck with them.
A target-date fund contains a mix of stocks, bonds, and cash that is generally suitable for someone your age. As you get older, the percentage invested in stocks automatically goes down and the amount in bonds goes up. You pick a fund based on your likely retirement year -- typically, around 65. If you're 30 today, you'd go for the 2040 fund. If you're 50, you'd look at the fund dated 2025. A 2010 fund is for people 65.
The flaw in these funds is that they might be too aggressive for people in their late 50s and 60s. Some 2010 funds were 65 percent in stocks before the 2008 crash -- much too much, if you were about to retire and needed your savings to pay your bills.
The companies that sponsor target-date funds in 401(k) plans need to rethink their choices. And you need a good strategy for picking the funds that will suit you best. Some guidelines:
Target-date funds are perfect for investors who are young and middle-aged. During those years, one size generally fits all. Most 30-year-olds should invest primarily in stock-owning mutual funds. Most 40-year-olds can afford to be 70 percent in stocks. Most 55-year-olds could reasonably hold about half their money in stocks and half in bonds. That's typical of what a sensible target-date fund will do.
After age 55 or 60, you can't automatically rely on target-date formulas any more. How you deploy your money depends on many more things than your age. You have to consider your health, employment prospects, how much money you've saved already, your retirement expenses, and how you want to live.
From a financial point of view, all 25-year-olds are pretty much alike," says Craig Israelsen, a professor of personal and family finance at Brigham Young University and a principal in Target-Date Analytics, which creates indexes for target-date funds. "But 60-year-olds are very different from each other." A pre-retiree with a substantial amount of separate savings might be happy with a fund that holds 50 percent in stocks. He knows that he won't need his target-date money right away. Someone in poor health with low savings won't want to take that kind of risk.
Corporate 401(k) sponsors might not be choosing the right kinds of target-date funds for their employees. There are two types of target date -- one called "to" and one called "through."
As an example of the difference, take a 50-year-old signing up for a fund dated 2025. A "to" fund starts out mostly in stocks and takes you to cash and short-term bond funds by 2025, when you retire. The money is managed to 2025 but not beyond. There aren't many "to" funds. But that kind of safety is what many pre-retirees thought they had, until the unpleasantness of 2008.
Most target-date funds are "through" funds -- meaning that they manage your money through your retirement date and beyond. In 2025, you still have a substantial exposure to stocks, for long-term growth. Assuming that you continue to hold the fund, your stock exposure will continue to decline, reaching a small but steady allocation by the time you're 80 or 85.
But are "through" funds best choice for 401(k) plans? That depends on what the companies expect their workers to do with their 401(k) money when they leave, says John Reckenthaler, vice president of research for Morningstar, which tracks mutual fund performance. If they want retirees to roll their money out of the plan and into an Individual Retirement Account, they should offer "to" funds. That way, new retirees won't have to worry about a market crash just before they leave the job. They can take stock of their circumstances and reinvest in the mix of stocks and bonds that now suits them best.
On the other hand, some large companies want to encourage employees to stay in the plan after they retire. Here, "through" plans make sense. They provide continuous money management for life, for workers who have learned to trust their 401(k)s. Pre-retirees could still be hit with a 2008-style crash. But they'd be less tempted to cut and run than if they were running the money themselves.
All this talk about how to use target-date funds is a waste of time if you're not saving enough money. A 65-year-old with $70,000 in a 401(k) can't choose to retire, no matter how well- balanced his or her investments are. If your health or the job market prevent you from working, your family will eventually have to help. "The solution is to get off our butts and save 15 percent of our income religiously," Israelsen says. That's what makes money last for life.
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