Setting and Forgetting Your Retirement Plan: Are Target Date Funds Right For You?

It’s easy to feel overwhelmed when thinking about retirement options, especially with so many investment choices available. One such choice is target date funds, which are often misunderstood despite being a common feature in many 401(k) plans. These funds are designed to simplify retirement investing, but only if you know how to use them properly.

In this episode of Capital Conversations, CERTIFIED FINANCIAL PLANNER™ professional Colin Day and Accredited Investment Fiduciary (AIF®) John Biedenstein break down what target date funds are, their benefits, and how to use them effectively in your retirement strategy. Whether you’re just starting your career or nearing retirement, this discussion will provide valuable insights to help you make informed decisions about your financial future.

For recent investment news and our take on the current market, retirement planning, and investment, listen to our podcast Capital Conversations or view our recent blog posts.

Below is the transcript for our most recent podcast, "Setting and Forgetting Your Retirement Plan: Are Target Date Funds Right For You?"

Colin Day: Welcome back, everyone, to another Capital Conversation. I am Collin Day, CERTIFIED FINANCIAL PLANNER™ professional, and with me today –

John Biedenstein: John Biedenstein.

Colin Day: John Biedenstein. How are you doing, John?

John Biedenstein: I'm doing wonderful. It's a beautiful Monday.

Colin Day: Yeah, it is. It's a beautiful day. Of course, you all can't see the beautiful day behind the camera, but it is a wonderful day, partly cloudy, much cooler than it was on Saturday when we had the art fair in town.

We're just communicating about the art fair, the places where we ate, the incredible humidity in St. Louis over the weekend that evaporated on Sunday when we had a very beautiful day. And I think today we're in store for another one. And we are also in store, John, for another great Capital Conversation.

Today, the topic du jour is all about target date funds, because target date funds are incredibly misunderstood. Did you know that, John?

John Biedenstein: They are. And they're supposed to be helping people. And I think that ultimately they do, but they need to be used properly.

Colin Day: Right. And the reason we're talking about this today is that, you know, there's this article from Pensions and Investments. If you don't subscribe, perhaps you should. The title of the article is “401(k) Participants Don't Understand Target Date Funds or Managed Accounts.” So this is from Cerulli, which we tend to use a lot for financial guidance in terms of what's going on in the ecosystem, what our clients or individuals are thinking about.

And from their research, when asked to select the correct definition of two investment products, target date funds and managed accounts, about two thirds, about 67% and 71% respectively, were either not sure or selected the wrong definition.

Because target date funds are offered on many of the retirement plans, almost all the retirement plans that we oversee at least, we felt like it might be important to have a conversation to make sure that we define it, that people come away from this conversation understanding a little bit more about their 401(k) options. Because, this is America and most people save in their 401(k) plans at work. They should know what their investment options are.

So John, I ask you, please, for the audience, help explain what is a target date fund?

John Biedenstein: Well, a target date fund is essentially one investment product that is set to assist a group of individuals that are within a certain age group to how they should manage their money until that age group reaches their targeted retirement age, which is often 65.

You can use it however you want to in regards to how it's handled. As we age, the investments become more conservative. As we're younger in our working career, we want through the investments to be more aggressive. So there's going to be more weighted to the stock market in your earlier years. And as you get older and closer to retirement, it's going to be weighted more to fixed income or more conservative or dividend paying stocks.

It's basically an autopilot type product where, you're within that group and it's going to manage it for you and does a very good job of managing it for you over time.

Colin Day: Yeah, I think about that old infomercial, “set it and forget it,” right? You’d hear the audience screaming out that. But when it comes to the target date fund, for some people it can just be that simple. I'm gonna have one investment in my portfolio that could take me literally through my working years all the way into – well, through – retirement.

So, for example, just in case you've never seen the target date before, they have vintages, John, just like your wine that you bought over the weekend has a vintage date on the bottom, it says like when this thing was actually bottled. Same idea with target date funds. 2065 if you're just entering the workforce. 2060, 2055, they normally operate in five year cadence.

So with regards to those funds, all they're doing is they're saying, “All right, well, hey, if you're not going to be retiring or considering retirement until 2060, well, you got a long time. And because of that, we're going to invest you aggressively. But because time catches up with all of us, you're going to get more conservative as you go.”

So that's where the kind of set it and forget it comes from. Whereas somebody that might be a lot closer to retirement – say they're going to retire in the next 10 years – well, if this is the year 2024, we'd be looking at the year 2034. And if it operates in five year vintages, we mostly just try to find the fund that lines most closely with your targeted retirement date. So this would be 2035. So your target date fund of 2035 is going to be a risk appropriate option for someone with about 10 years to go.

John Biedenstein: Correct.

Colin Day: But, of course, it can't always be that simple, John. There's varying types of target date funds, so what could you tell us about the varying kinds of target date funds that do exist out there?

John Biedenstein: Well, target dates have kind of two different types. If you think about it, you're managing money either to retirement, or you’re managing money to and through retirement. So what that means is, in your example, somebody that might retire might be set to retire in 2055. So managing to retirement is to say, “I'm going to allocate your assets and make changes to the portfolio so that at 2055 or 2060, when you're going to start using these funds, they are set in that more conservative vehicle. Now as you continue to age, they just maintain you in that 2055 or 2060 strategy.

There are also target date funds that manage to and through retirement. So those would be ones that, at age 55 or age 60, you might be in a 2055 fund and continue on, and it's going to adjust it a little bit more, again, being more conservative as time goes on. There's a lot of newer discussion in the workplace retirement plan sector about retirement income vehicles. These are not retirement income vehicles, where after you're through retirement, it's going to start generating income back to you. Candidly, the funds can be set up to do that way via doing withdrawals, but they're not set up to generate income to go be paid back. Does that make sense?

Colin Day: Yeah. Well, I mean, it makes sense to me. But when it comes to the target date funds, the other thing that I'll just briefly mention is the fact that not all target date series are built the same. I think that's your point. There are various companies that all have different ways of migrating off risk.

Some of them are going to start more aggressive. Some of them are going to start more conservative. Some of them are going to drop off a cliff. So we might find a mutual fund family that performs really well when you're very aggressive, and then they drop off a cliff, and then they become very conservative, and then against their peers, they're just not as good.

And so that's why we, helping our clients decide the 401(k) lineup, we're trying to find the best target date series that fits whatever that client base needs. So when it comes to different kinds of choices, there's all these different kinds, and again, we could talk about this for hours, probably.

But in terms of how they work, I think we've got at least a general understanding. Again, starts more aggressive, gets more conservative. Technically, it could be one particular fund for your entire life. But if we think about those people that really like this idea or don't like this idea or are looking for a reason to make a change, John, what are some of the pros as to why someone might want to consider using a target date fund for their retirement investing?

John Biedenstein: Yeah. So, one pro or a benefit to target dates they're autopilot investing. So you're pegged into that group, and over time you're going to continue to be managed in regards to that. So it's tailored to your age, tailored to your expected retirement date. It's not taking into [account] how much you've saved, how much you need to have at that point in time; it's just continuing to manage it.

Another advantage or pro would be it's an all in one product. It's that manager, whether it's a mutual fund company, that's a passive manager – meaning, indexed manager – or it's an active manager. They're using different funds within their menu to fill in the blanks. So earlier in your career, when you're 20 or 30 years out, they're going to be putting in a lot of growth equity, a lot of small cap growth, a lot of emerging markets, a lot of these growth-based securities. And as you get older and closer to retirement, it's going to be using more fixed income vehicles, more dividend paying stocks and those types of things.

So it's an all in one product and it's diversified. So you don't have all your eggs in one basket. I can't tell you the number of participants we work with that over time they choose a stable value fund, maybe because they're concerned about the market and things are happening. So they put their money in stable value and they set it and forget it there. And the disadvantage of that is you earn that rate, that base rate for a period of time. So the market has its very good years; you're not participating in that with a target date. It's well diversified, so you're participating in the market activity all through that time.

Colin Day: Yeah. And I think, one of the interesting things when it comes to target date funds is that they are designed to be an inclusive investment. You don't need to technically diversify out of it.

So, for example, we'll run into people, I've run into people that have several target date funds in their portfolios. Where, “Hey, my targeted retirement year is 2045. But I want some of my money to be a little bit more conservative. I'm going to be in the 2040 model, but then I also want to be a little bit more aggressive, so I'm going to choose the 2050 model as well. So you end up with, in this case, three different target date funds in there.

But again, because most retirement plans, [however] they're built, they're all built on the same underlying investments, which just means you've duplicated the investments. You've diversified, but only within the investments that were already in the appropriate options. So the S&P 500 exposure, yeah, it might be lower in one and higher in another series. But it's all averaging out because all you did was just include other options. So for most people it's just one particular option on there.

With that being said, some of the cons that we might be thinking about, John, might be just this misunderstanding about how target date funds work. But what [are] other cons of working with a target date funds that you can think of?

John Biedenstein: As I mentioned before there are passive or index face target date funds that are all indexed strategies. Most target dates are either actively managed or they're a blend of active and passive. So, the funds that are actively managed or active and passive are typically more expensive because you're using a little bit of active managers that hopefully pay dividends and pay alpha over time. But that's going to be a little bit more expensive over the long term because you're not specifically using passive investment managers.

Another con of target date series are their long term strategies, which is what you want. These long term managers aren't tactically adjusting things. So for example, we've been through a period of high inflation that's impacting investors in `23, `24, and we'll see how much longer. Target date funds probably aren't tactically managing those, because their goal is to be – the ones closer to retirement would be, but the further away wouldn't, because again it’s a long term view. It's more of a look down the road, 15, 20 years from now. So they're not making tactical changes that you might see in other managers.

Another thing is, as I mentioned before, it's a set strategy. And it's a set strategy that works very, very well. We work with some small employers or we work with clients at very small employers that have a retirement plan and maybe don't – and this is a good thing – maybe they don't have a plethora of choices available to them. Which is candidly a good thing because it can confuse people more. But they provide a target date series, which you can get all the diversification that you want in the target date series and, not use all these plethora of choices. So for all intents and purposes, they can be set goals. And if you want to adjust them – the only good example where I've talked to somebody and they had two target date funds within their plan and they said, “Well, I try to carve out a little bit of it for my target date. I'm set to retire in maybe 2045, but my target date piece, which is in the 2055 or 2060, that's my Roth money.” So that kind of makes sense.

But the reality is a lot of people that just choose it from the point of view of, “Well, I want to choose two.” That's not – because they are conflicting and they're kind of going against each other.

Colin Day: Yeah. So I think that's a good point. The one area where I'll say that it makes sense to have your target date fund and other investment options is when you can invest the sources of the money differently. And it's very rare that record keepers allow for this, but those that do, they're worth their weight in gold. Because then you can say, “Hey, I want my pre-tax money to be invested one way and my Roth another way.”

And so that would probably be the gold standard reason that you might want to have multiple target date funds or a target date fund and other kinds of investment options. Otherwise, there's a lot of duplication and overlap within these.

So, John, we've talked about what a target date fund is. We've talked about the pros and cons of them. Any other parting thoughts, anything else that you want to communicate to folks in regards to you know, how 401(k)s work or how they should be thinking about their investing?

John Biedenstein: Well,the article did mention managed accounts. Managed accounts are basically a robo advisor. Oftentimes it's tailored based on there's a third party that's a robo advisor that's providing that advice in regards to the individual fund choices.

Oftentimes folks use managed accounts and they can be effectively used if they're made available for the plan. Oftentimes they're expensive. Oftentimes you can turn them off and turn them on. Maybe you get the advice and turn it off.

So managed accounts are something that we've seen. They are prevalent. But I'm not a big fan of using managed accounts because I think target date series and using an advisor or using other tools within a plan might be more beneficial.

Colin Day: Sure. Absolutely. And I think it just comes down to identifying what the options are and understanding your options.

We have clients that I talk to, and said, “Hey, do you know that you're paying an extra 50 basis points – which is an extra half a percent – to a manager just to run your account?” And they say, “No, I had no idea.” Well, when you're defaulted into that, or if you don't understand your options, sometimes it's going to happen to you.

And really, that's what this is all about. It's just educating you all in the audience to better understand your 401(k) – which again, for many folks is where they primarily save for their futures – so that you can make better decisions. And whether it's a target date fund or understanding now better about a target date fund, so you realize that you don't want to invest in a target date fund, whatever it might be, you're more educated for it.

So John, thanks again for joining me today. I appreciate it.

John Biedenstein: Thank you. I hope this is helpful.

Colin Day: Yeah. And you'll be hearing a lot from us, I think, in the near future.

So with that being said for John Biedenstein, I'm Colin Day. Thanks much for joining us for another Capital Conversation. We'll see you in the next one.

The opinions expressed in this program are for general informational purposes only and are not intended to provide specific advice or recommendations for any individual or on any specific security. It is only intended to provide education about the financial industry. To determine which investments may be appropriate for you, consult your financial advisor prior to investing.

As always, please remember investing involves risk and possible loss of principal capital. Please seek advice from a licensed professional. Correct Capital Wealth Management is a registered investment advisor. Advisory services are only offered.

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By understanding how target date funds work, you can make better choices for your 401(k) and ensure your investments align with your retirement goals. For personalized financial advice tailored to your specific needs, reach out to us at Correct Capital Wealth Management. We help guide individuals and families through their investment options and also work with businesses of all sizes implement retirement plans for their employees. Give us a call at 877-930-4015, contact us online, or schedule a consultation with a member of our advisor team today. It only takes 15 minutes to understand if you're a good fit