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This Is Becoming Millennials' Favorite Investment

By Dan Caplinger - Sep 12, 2018 at 5:15PM

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But is it a smart choice?

Everyone seems to have an opinion about the investing behavior of millennials. Like most other investors, millennials want convenient, simple ways to invest that will help them achieve their financial goals. Based on what these young workers are doing with their retirement plans, millennials seem to be gravitating toward what many see as the perfect all-in-one investment vehicle to save for retirement: target-date funds.

Nearly two-thirds of workers in their 20s who participate in 401(k) plans at work use target-date funds in their investment strategies, according to the latest available research from the Employee Benefit Research Institute. That compares to less than half for workers in their 60s. With many employers offering target-date funds within their menu of investing options, the availability and simplicity of these funds makes them an obvious choice, and recent hires are gravitating toward them now more than ever.

Five smiling young people in a cafe with coffee cups on a table in front of them.

Image source: Getty Images.

What exactly is a target-date fund?

One of the biggest appeals of target-date funds is that the concept behind them is easy to understand. The idea is that each fund targets those who intend to retire or otherwise get access to their money at a certain date in the future. In order to accommodate this time horizon, the investments that each target-date fund start out having an aggressive growth objective when the target date is far in the future. Over time, the fund then shifts to a more conservative approach, balancing growth and income needs gradually over time. By the time the target date is imminent, target-date funds have a greater emphasis on capital preservation than on future growth.

Target-date funds have several other advantages. Like many funds, they offer immediate diversification across a wide spectrum of investments even for those who don't have much money to invest. What makes target-date funds stand apart from other investments, however, is the automatic way in which they adjust their investing exposure over time. Rather than making you recognize the need to adapt to changing circumstances as you grow older, the target-date fund itself makes adjustments internally, saving you the trouble of tracking their moves and letting you rely on the predefined investment strategy to work over the course of your lifetime.

Are target-date funds perfect?

As attractive as target-date funds are, they do have some potential shortcomings. Some fund providers tack on significant amounts of additional fees for their target-date fund offerings, taking the opportunity to double dip by using other mutual funds from the same fund family but then adding separate management fees for the target-date fund itself. Critics argue that's inappropriate, with the better way of handling it simply to pass through the costs of the underlying investments without any further fees.

In addition, various target-date funds have different philosophies about exactly what happens on the fund's target date. Some investors erroneously assume that the fund will be entirely invested in capital-preserving investments like short-term bonds, having gotten rid of all of its riskier holdings. But many target-date funds are designed for retirement investors, and fund companies note that even those who've already retired still need at least some growth in their portfolios to handle what for many can be 30 years or more of living expenses in retirement.

As a result, most target-date funds have at least some stock market exposure even on or after the target date. If you're not aware of that risk, then it can surprise you when what you think is a conservatively focused target-date fund suffers significant losses during a stock market downturn. That's what happened during the 2008 market meltdown, and even after adjusting their investment objectives somewhat, target-date funds still tend to keep stocks in their portfolios even on their target date.

Be smart with target-date funds

As long as your employer is smart about choosing a fund provider that charges low fees, then a target-date fund is a good, simple way for anyone -- millennial or otherwise -- to save for retirement. If your employer's choice of target-date fund is unreasonably expensive, however, then it's worth looking for a cheaper alternative within your plan -- although in some cases, you might not have a less costly alternative.

Like just about any investor, millennials value convenience in their investments without unnecessary complexity. Target-date funds keep things simple, so it's easy to see why they've become so popular among younger investors.

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