Your savings will be spread among a number of assets because a Target Date Fund (TDF) invests in a variety of underlying funds, however diversification is not quite that simple. The question is the overall asset allocation and how it will change over time. Most of these funds will begin with an aggressive allocation, a higher percentage to equity, and become more conservative as you reach retirement, transitioning from equity to fixed income. The appeal of a TDF is the set it and forget it approach. However, consider the process of a financial professional, they work extensively with clients to determine a number of individual factors to achieve your financial goals. They examine your entire financial picture, assessing risk tolerance, liquidity needs, expected retirement/time horizon, tax situation, unique circumstances etc. This illustrates that asset allocation is not a one size fits all approach; you may be diversified in terms of number of investments but not effectively spread across asset classes. The asset allocation provided by the fund may not be appropriate for your specific financial situation. TDFs do not generally offer alternative investments like commodities or real estate, which may be valuable from a diversification standpoint. Even further, within each asset class you want to ensure that you are diversified; for example, if the fund offers an overall asset allocation of 60% equity and 40% fixed income, but 70% of the equity is invested in US Large Cap Energy Stocks that would not be well diversified. Fees associated with TDF’s can be rather high, eroding returns, it is important to consider the after tax and after fee returns compared to other available investment options. Lastly, changes in your financial circumstances may require a change of target date fund, remember to periodically reevaluate your options keeping your long term financial goals in mind. It is crucial that you know what is actually held in the fund and determine the overall asset allocation currently and how it will change over time. You want to be aware of how often the TDF is rebalanced, ask yourself if the broad asset allocation is appropriate as well as the breakdown within each general asset classes. Due diligence for these funds is a must.
** The information provided should not be interpreted as a recommendation, no aspects of your individual financial situation were considered. Always consult a financial professional before implementing any strategies derived from the information above.
Target Date is not a excuse to set and leave it alone and assume all is well. It serves the purpose for simple approach to select an allocation and then know that as the years roll on the allocation will have less stocks and more bonds and hopefully address risk along the way. There are a couple of more questions that should be raised here like, what is your time horizon? How much money do you have? Are there special cash flow needs to address like the withdrawal for auto or other items? Cash flow needs and risk will dictate potentially if you are correctly positioned and diversified for your risk and cash needs. An example of how cash flow might drive the solution is not all target date funds have the same cash flow or risk for the specific date. Higher cash flow needs may suggest higher yielding bonds or annuity or real estate investment trust or the like to be incorporated. Overall if someone has only a few thousand dollars then a target fund may be the best choice and could serve to diversify enough.
Ryan, the other answers here a quite good. I would only add that you need to understand the underlying asset allocation for each fund you are considering. Each company that offers a series of target date funds builds them differently, and if you don't understand what they're actually buying you might be surprised at how volatile they can be. Note how poorly these funds did of protecting investor's principal in 2008, and since. Some other fund categories you might want to consider are Moderate Allocation and Conservative Allocation funds. And as the previous entries have indicated, you will want to consider the nature and time horizon for your goals, and your other resources in a big picture view before buying a fund or two because they're supposed to be "safe", or some such notion.
To answer that question, you need to know more. Target date funds, in general, are asset allocation models that are on a “glidepath” to become more conservative over time. But to understand the suitability of a Target Date Fund, you need to know what strategy is being employed and how it is executed (by a computer or a person? At what intervals? What is the asset allocation model?). Furthermore, you should question whether you want to arrive at retirement with a very conservative portfolio: after all, one member of the average couple will live into their nineties, so even at retirement age, most people still should have a very long investment horizon during which they must grow their assets at least at the rate of inflation.
Target date funds have become popular because they provide some of the diversification that an asset allocation program does. However, they have several problems in actual practice. They were criticized for not doing a better job of protecting their shareholders during the market crash of 2008 - 2009. They provide a one-size-fits all solution rather than a specific solution to an individual need. They may not be as conservative as you think they are as they near their target date. They are designed to move more money from stocks funds into bond funds as you get older. This may seem to be a good idea, but many analysts are beginning to wonder how well these models will perform if interest rates rise and the value of bonds declines. You may want to see if you can get some professional guidance and create your own investment program using some of the other funds that are available in your plan to create a model that meets your needs and appetite for risk.
Ryan you have several excellent answers above to help. You need to consider the TDF's allocation and how this might fit with any outside investments you might have. I've written several articles on TDFs that might be of interest: http://money.usnews.com/money/blogs/the-smarter-mutual-fund-investor/2012/03/07/evaluating-your-target-date-fund-options and http://money.usnews.com/money/blogs/the-smarter-mutual-fund-investor/2011/11/09/true-or-false-target-date-funds-guarantee-retirement-success and http://money.usnews.com/money/blogs/the-smarter-mutual-fund-investor/2011/03/30/5-considerations-for-investing-in-target-date-funds
In my professional opinion, Target Date Funds are not really designed for anyone but the most "typical" investors. How many 60 plus year olds do you know that are not conservative at all? How many 22 year olds do you know that will never save again if they lose one penny in the market? These folks are not typical and TDFs are a horrible fit for them. A much better fit for almost anyone looking for a fully managed model is to use risk based asset allocation funds (Lifestyle Funds). These funds simply model an investors aggressive, moderately aggressive, moderately conservative, or conservative needs. They stay the same and do not change over time. The investor can move themselves up or down in risk based on their own risk tolerance and time frame.
Target Date funds are like the new easy button of investing. On paper they seem like an easier way to invest and forget about it, however, there are many more sophisticated ways to increase diversification and protect against losses. Investing is like anything else in that slight improvements can have huge long term implications. For the reasons listed by my colleagues in their insightful answers and the fact that target date funds are missing many asset classes that provide opportunity for gains and sources to protect with uncorrelated assets I feel that they are much lacking and not an easy button at all.
There is another issue with target date funds. Typically, the portfolio re-allocates to become more conservative as you get closer to your "retirement" ( i.e target) date. For example, if your target date is your age 65 , the portfolio will be extremely conservative by then ( i.e. mostly bonds and cash). But it begs the question: will you be withdrawing your ENTIRE portfolio on that day? Probably not! Hopefully you will be taking small, periodic distributions - for the rest of you life - which could be 20, 30, 40 years- particularly if you are married and need to plan for two lifetimes. So you may end up invested too conservatively at your target (retirement) age. While I like the idea of a managed portfolio's for most investors, a target date fund just might be too generic and rigid, where asset allocation models that you can switch between offer us more flexibility. Please contact me with any questions. Best of luck! Evan
If you are the type of investor that is not comfortable with making changes in your 401K asset allocations or don't feel you have the time to watch your account closely (or don't have the temperament to watch it closely), then Target Date Funds may just be perfect for you. I would check to see if there are any non-market correlated alternative options to select from, these would be assets that don't track the markets (and there may be some in the TDFs) like real estate, precious metals etc. Aks your HR person at work or ask them to put you in touch with someone who can give you more personalized advice.
The information provided should not be interpreted as a recommendation, no aspects of your individual financial situation were considered. Always consult a financial professional before implementing any strategies derived from the information above.