2012: End of the World? Or the End of Your Target-Date Fund? (Part 3/3)

In the first part of this three-part series we reviewed the fundamentals of target-date funds. Then we talked about why target-date funds are going to be hard to avoid in Part 2 . Here we’ll finally step through some of things you can do to be smart about target-date funds.

1. Get informed, then get invested. Remember that you can always opt-out until you’re informed. It’s crucial to remember this: No one can control your money for you. If you don’t like the investment choices in your company’s retirement plan or don’t understand them, you can tell them you don’t want anything to happen with your money. Now that said, if your company offers a retirement plan, it’s highly likely that you’re better off participating, but until you make sure that you understand your options, it might be better to opt out. Again: Get informed, then get invested. Same goes for your investment accounts outside of the office.




2. Every target-date fund is different. Here’s where it pays to be smart and to remember that mutual fund companies are pouring money into advertising and marketing for their target-date funds. If you’ve forgotten why, review Part 2 of this series. All of the fund companies will try to convince you that everyone’s target-date fund is the same except theirs. They want you to think that only their funds are different, special, the best. So pause for a minute – can all those claims simultaneously be true? No way.




3. Understand how and why target-date funds differ from one fund to the next. It makes sense that one fund company’s 2015 fund will be different from the 2025 and 2035 funds that they also offer, but what about all of the 2015 funds that are out there? Well, fund companies will use a fancy word – glidepath – to try to convince you that they are incredibly smart and sophisticated and therefore that you should invest with them. Just as Kentucky Fried Chicken’s “special sauce” is what makes their chicken different from everyone else’s, the glidepath is the special sauce that fund companies use to differentiate their target-date products among everyone else’s.
   
   The different glidepaths are why one company’s 2025 fund will have a ratio of investments in stocks and bonds that differs from the next company’s 2025 fund. And those glidepaths will also determine the different rates at which they make adjustments and how those adjustments are made. Just like there are alternatives to KFC’s chicken and those alternatives each have different recipes, the key thing to understand is that within each and every specific target-date option (2010, 2015, 2020, etc.) there are multiple funds and those will range from more aggressive to more conservative. If you invest, you need to be comfortable not only with the time horizon, but also understand your risk tolerance.




4. Understand how to use target-date funds. One of the biggest mistakes that people make when they invest in target-date funds is that they invest in other funds along with the target-date product. Assuming you’ve figured out which target-date is best for you, then it’s the last thing you should be doing. Instead, think about investing in a target-date fund as a single alternative to investing in a separate group of individual stock and bond funds. Remember, the point of the target-date fund (and asset allocation funds in general) is that they provide diversification through one investment.




5. Target-date funds are a buy-and-hold product. Target-date funds aren’t really intended for short-term investors; most are developed for the retirement savings market. And since so much work goes into planning the glidepath (see #3 above), they’re developed with the end date in mind. If you need to invest money for other purposes, then you should probably be thinking about other options.

For a practical 1-2-3 on next steps you can take, read our next blog post: How to Navigate the Tricky Territory of Target-date Funds. Coming Soon!