Missing the Target

Mark Eckman

USE THE RIGHT TOOL for the job and you’ll get the best result. If you need to connect two boards, you could use a hammer and a nail or a screwdriver and a screw. Either methods work—and they’re certainly better than banging in a screw with a hammer, which I’ve seen tried. It was not effective.

Participants in 401(k) plans, alas, display similar behavior with target date funds, or TDFs. A TDF offers a diversified portfolio in a single fund, with the mix of stocks and bonds changing as you approach retirement. When used correctly, the fund’s asset allocation should be appropriate for your age—aggressive while you’re young and becoming more conservative as you age. There’s no need to trade or adjust the mix. The fund does that automatically. The evidence, however, suggests many people use TDFs incorrectly.

Vanguard Group found that 52% of 401(k) participants have invested in a TDF, making the funds a popular choice for retirement money. But it seems many folks don’t stop at one fund. Morningstar studied TDF users and found many also invest in other funds—sometimes another TDF and sometimes other funds offered in their 401(k) plan. Result: These additional funds change the retirement saver’s asset allocation, so it may no longer make sense, given the employee’s expected retirement date.

Indeed, as a plan administrator, I’ve seen participants hold as many as 12 TDFs. Some participants have told me their financial planner recommended buying multiple TDFs. What can I say? It sounds like another case of using a hammer with a screw.

But what if you don’t like the risk profile of a particular TDF? Morningstar recommends you choose a single fund with a target date closer to today if you want a more conservative portfolio or, alternatively, a date further away if you want something more aggressive. In other words, you don’t need to own more than one fund to adjust your risk.

Check with your 401(k) plan’s administrator to find out how the plan uses TDFs. Many plans automatically enroll you in an appropriate TDF when you become eligible to contribute, unless you choose an alternative. Some plans may, by default, also deposit company contributions in a TDF. Don’t want to own the default TDF? You can probably change the fund selection with a few clicks of your mouse.

Mark Eckman is a data-oriented CPA with a focus on employee benefit plans. His previous articles were Alphabet SoupFinancial Pilates and Giving Voice. As Mark approaches retirement, he’s realizing that saving and investing were just the start—and maybe the easy part. His priorities: family, food and fun. Follow Mark on Twitter @Mark236CPA.

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