Understanding Target-Date Retirement Funds

One of the biggest stumbling blocks to successful retirement is saving enough and investing well. Retirement companies and workplace 401(k) plans have attempted to tackle that by harnessing the strongest force in human history — inertia.

You won’t save early enough. You won’t save at high enough levels. And you definitely won’t pay attention to your investment mix. There’s a lot to be said for the hands-off approach, but that assumes you start in the right place and that someone has given you decent initial guidance.

The target-date fund purports to be the answer. You have to save enough, yes, but the rest of these issues seem to be put to bed by just buying a target-date fund and letting go of the details.

Easy enough, right? Here are some pointers to consider before plunging your IRA money into these funds and clocking out for 20 years.

1. Understand what’s inside

Buying a target-date fund means buying a collection of underlying investments, usually mutual funds picked by a manager. You might assume that the mix of equity to bond funds is the right combination for your goals, but do a little homework here. You might find a wild mix of aggressive strategies that simply don’t fit your thinking. Shop around.

2. Understand the fees

The assets you own inside a target-date fund could be direct holdings of equities and bonds or mutual funds with expensive fees attached which then trade equities, bonds or other asst classes. It might be simply a collection of index funds, which will be cheaper, or similarly inexpensive index ETFs. Make sure the cost of the fund is in line with your expectations.

3. Understand the “asset evolution”

Over time, a target-date fund will move from an aggressive, stock-heavy mix to more income-oriented, bond-focused holdings. While the date in the fund’s name (say, 2030, 2040 or similar) might suggest that the end year means owning mostly bonds, find out how fast that happens and exactly what the final mix will be.

4. Understand your longevity

Once you have a shopping list of funds, consider how many years are likely to live. The Centers for Disease Control puts the number at 78.7 right now, but it varies by gender and making it past a given milestone, say 65, implies a longer life, out to 84. Living to your 75th year implies 87 on average. That can change your ideas of the proper stock-bond ratio in a target-date fund.

Target-date funds are useful tools. They cannot, however, substitute for thoughtful, hands-on management of your own money in the context of your life and personal goals. Be aware of their limitations and consider the alternatives, such as tending a low-cost portfolio on your own.