There is a good chance your 401(k) default mutual fund option is a target date mutual fund. A recent study by Fidelity confirms that fact. A whopping 98% of all employers allow workers to invest their 401(k) money in a target date fund. And 92% of 401(k) accounts use them as the default option.
I am an investment advisor to individual 401(k) participants., I am never satisfied to follow the herd. I am not convinced target date mutual funds are the best 401(k) investment option.
Target date funds increased in popularity after the Pension Protection Act of 2006. A QDIA (qualified default investment alternative) is a 401(k) mutual fund option.
The target date funds qualify as a QDIA for 401(k) participants who do not take the time to pick mutual funds on their own.
What is a target date fund?
Target date funds are a one-size-fits-all investment. For example, a target date fund with a 2035 date is for someone who will retire in or near 2035. This mutual fund provides a mixture of stocks and bonds for all investors retiring in 2035.
I have been an investment advisor for over 38 years. All individual investors retiring in 2035 do not have the same stock and bond market risk level.
A target date fund allocates 401(k) investment into a pre-determined asset allocation. This allocation is a function of age. That is all. Age is the only investment criteria.
Target date funds invest less money in stocks as you get older. At the same time, they invest more money in bonds. The assumptions are that your stock market risk tolerance is lower as you get older.
Always read the fine print. Some target date funds claim active management. Actual humans pick how your 401(k) stock and bond investments. Some target date mutual funds claim passive management. These mutual funds select investments via algorithms.
The biggest downfall to target date funds in a 401(k) is the high annual fees. There are always lower-cost and better-performing mutual funds on a company 401(k) menu.
Are you interested in lower annual 401(k) mutual fund costs? If so, it may be time to consider other 401(k) mutual fund options.
Academic research is one thing. Real life investment advice to real individual investors is another. Each concludes that all investors are different. A one-size-fits-all target date funds may not be a good fit for as many 401(k) participants who use them.
Ric Lager
Lager & Company, Inc.
