The Right Level of Retirement Income

Imagine you’ve reached a point in your life that you are done working, the end of the rat race, no more bump and grind. You are now ready to live the rest of your life doing just about anything you want, or nothing at all, it’s your choice. You have saved so much money for retirement and perhaps you may be receiving a pension or if you’re lucky, social security. The thought goes through your head: did I save enough?

Who Should Use Target Date Funds?

Target Date Funds

The use of target date funds in 401K plans is growing rapidly, particularly now that employees are automatically enrolled in their employer’s 401K plans upon joining the firm. If an employee doesn’t want to participate, they have to opt out, unlike in years past, when you had to actually sign up to contribute.

The rule is a good one because most people don’t put enough away for retirement and getting people to sign up is extremely challenging. By the same token, people who are automatically enrolled tend not to make the effort to opt out. The problem is that most people who contribute to a 401K have no idea what to invest it in. And even if they received some sort of guidance from the plan provider, there is usually no follow up to ensure the portfolios are rebalanced and certainly no guidance on potential changes to investments due to changes in an employee’s situation. Enter the often misunderstood target date fund.

A target date fund is designed to be a single fund solution for investors with neither the time, expertise, or desire to spend time managing their investments. The concept is quite simple: A target date fund is designed to provide a dynamic asset allocation depending on the expected retirement date of a particular investor, investing more conservatively as the ‘target date’ approaches. For example, an investor expected to retire in 2045 would still have over 30 years of income generation.

A target date fund for 2045 would most likely be heavily invested in equities, as the diagram below indicates. As the year of intended retirement approaches, the exposure to equity diminishes. For example, the 2015 fund, which is intended for someone about to retire, only has approximately 35% in equities, therefore diminishing the risk of

Target date allocations

the portfolio as the time to begin withdrawals draws near.

Target date funds can include a variety of asset classes such as US equities, international equities, emerging market equities, sovereign fixed income, corporate fixed income, high yield, emerging market debt, commodities, real estate, currencies, etc.  They are great tools for portfolios whether in or out of 401K plans but they are not for everyone. Who should invest in target date funds? The inexperienced – if you don’t have much experience investing, you are better off choosing a target date fund.  Just set it and forget it.

Unless you develop enough investment experience and are willing to periodically (quarterly)evaluate your investments, this is the way to go. The time constrained – while managing a portfolio of mutual funds does not entail the same level of diligence required to invest in individual stocks, investing still requires periodic monitoring of your portfolio and rebalancing when necessary. If you don’t have the time to periodically monitor your portfolio, including being well informed about economic and capital markets, invest in a target date fund. The disinterested – and I don’t mean that in a critical way.

I’m referring to people that may have some experience with investments and can afford to spend some time on them, but choose to do something else entirely. If you meet any or all of these criteria, you should seriously consider investing in a target date fund. If, on the other hand, you are the opposite, you may want to consider developing your own asset allocation and tactically managing your portfolio as you see fit. For additional guidance, read Asset Allocation, Core Satellite Investing, and Active vs. Passive Investing.

You may also want to consider the following books:

Fiduciary Handbook for Understanding and Selecting Target Date Funds: It’s All About the Beneficiaries, by Ron Surz

Investing for Retirement, by Virginia Morris

A Beginners Guide to Investing: How to Grow Your Money the Smart and Easy Way, by Alex H. Frey