If you have years of investing experience behind you, you're used to having a lot of choices about where to put your money. That's one reason why investing in a company-sponsored retirement plan, such as a 401(k) plan, can be so frustrating: You often don't have a good selection.
However, according to a recent study, an increasingly popular retirement investing option has gotten a lot more attention from workers in recent years. And although it may not be a perfect strategy for every investor, this investment vehicle could give you a big upgrade over other inferior options in your retirement plan.
Hitting the target
The vehicle is the target-date mutual fund, and it has taken the 401(k) world by storm. A study from the Employee Benefit Research Institute took a look at how retirement plan participants are using target funds for their retirement savings. The results were encouraging -- of those plans that offer target funds, 37% of participants put at least some of their money in a target fund. Moreover, target funds collectively hold about 7% of all 401(k) assets.
The study cites a number of factors that could contribute to rising use of target funds. One is the fact that many employers are using automatic enrollment to get more of their employees to make retirement plan contributions, and they're putting those automatic contributions into target funds.
A fair number of employees rely solely on target funds for their retirement savings. If those participants had chosen a single fund regardless of what investment options were available, a target fund clearly has some advantages that other types of funds would lack, in terms of diversification -- few other options would include exposure to so many different kinds of investments in a single fund.
Target funds aren't all the same
Not all experts agree that target funds are beneficial. Last year, for instance, many supposedly conservative target funds did poorly because they had fairly high exposure to stocks, even for target dates that weren't too far in the future. That brought substantial declines that many fund investors were unprepared to see.
The study looks further at that phenomenon, noting that funds from different fund families take very different approaches to the question of how much to hold in stocks. For 2010 target funds, allocations to stocks ranged from around 25% to 65% among the funds the study examined. Given that such a fund would typically be intended for someone retiring next year, one could easily argue that holding 65% of your portfolio in stocks was overly aggressive.
Some funds, however, make an effort not just to cut stock exposure but also to invest in more conservative stock funds. For instance, T. Rowe Price
Target funds for investors closer to their goals, for example, include substantial allocations to more conservative choices, such as a general stock index fund that includes large companies like Procter & Gamble
In contrast, those further away from their target get higher allocations to more aggressive growth funds that invest in companies like Apple
Know the pros and cons
Target date funds are far from perfect. Although they automatically adjust your asset allocation over time, they also take all the control over your investments out of your hands.
But in a 401(k) plan where other investment options are often worse, target date funds are a breath of fresh air for employees. So it's not surprising that more workers are taking advantage of them -- and given how important a diversified portfolio is to investing success, it's definitely a good thing that they are.
For more on smart retirement investing, read about:
- The first step toward rebuilding your retirement.
- The top 5 financial lies of all time.
- Will you ever get to retire?
