Several years ago, congress passed a law encouraging employers to automatically enroll employees in 401 (k) accounts. This means that the employer sets the minimum contribution, which is about 2.6 percent of earnings, according to the Bureau of Labor Statistics. However, here is the challenge:
If employees don’t select their own investment allocation, 401 (k) accounts “default” to the employer’s choice.
On the approved list of “default investments” are target date funds. A target date fund typically offers a portfolio mixed with stocks, bonds and mutual funds, becoming more conservative as the employee ages. However, when the market crashed, target date funds encountered some challenges.
Target Date Fund Changes
Around 2008, two of the largest target date fund managers, Fidelity and Vanguard, changed their fund make up. Essentially, investors were now holding more equity funds later in life. And this was fine, until the market crashed.
Investors in these funds, which included the Fidelity Freedom and Vanguard Target Retirement, lost 26 to 29 percent of the fund value, over a 12 month period. However, despite this crash, money continued pouring into these funds – begging the question ‘Why?’
Target Date Funds Grow
Since 2008, target date funds have grown to $380 billion in assets, according to CNN Money. In fact, estimates suggest by 2020, target date funds could make up half of all assets in workplace retirement accounts. That’s because these funds are still set on “default” on many employer 401 (k) plans.
Employees are auto-enrolling in these programs, without paying much attention to their options. However, before setting your retirement on autopilot, pay attention to the fund make up to ensure its right for your situation.
Target Date Fund Quick Guide
Each target date fund is different. And, if you choose to invest in this type of fund, there are a few things to know. First, evaluate the fund’s bond holdings. A quick rule is to hold your age in bonds, and the rest in equities, according to CNN News. You don’t want to outlive your retirement funds, so selecting a target date fund with enough bonds, makes a difference.
Also, think about the amount of risk you can handle, in terms of your future retirement plans. If the risk seems too great with the fund, select a target date fund with an earlier retirement date.
And don’t forget to pay close attention to stocks included in the fund. For example, Fidelity holds about 50% of stocks near retirement, while T. Row Price holds around 64 percent, according to CNN Money. A high percentage of stocks work alright for a young investor. However, as you get older, it’s important to take control and develop a real plan for your retirement account.