Are you using your target-date retirement fund the right way?
Target-date funds are a popular choice in corporate 401(k) plans. Their adoption surged after the Pension Protection Act of 2006. This law encouraged businesses to automatically enroll employees in these funds. Today, around 80% of 401(k) plans offer target-date funds. These funds now hold the most assets of any investment option.
Target-date funds are simple and efficient. They are managed professionally to align with your retirement timeline. However, many employees make mistakes that reduce the benefits of these funds. Let’s look at the three most common mistakes and how to avoid them.
Using More Than One Target-Date Fund
- The Problem: The main benefit of a target-date fund is its simplicity. It automatically adjusts investments as you approach retirement. These funds start with a focus on growth. Early in your career, they hold more stocks, typically around 90%. As you near retirement, they shift to a more stable mix with bonds.
Despite this, many employees add a second fund to their portfolio. They think it provides extra diversification or boosts returns.
For instance, an employee investing in a 2040 target-date fund might also buy a stock-heavy index fund. They believe this will add growth. In reality, this approach disrupts the target-date fund’s balance. It also creates unnecessary complexity and risk.
- The Solution: Use just one target-date fund for your entire 401(k) plan. These funds are designed to offer the right mix of stocks, bonds, and other assets. Trust the fund to do its job without adding more investments.
- Example: A 35-year-old employee chose a 2055 target-date fund. Later, after seeing its strong recent returns, they added a high-risk stock fund. When the stock market dropped, their overall portfolio suffered. This added risk wasn’t necessary, so they decided to stick with the target-date fund. It provided better balance and reduced stress.
Setting It and Forgetting It
- The Problem: Many employees set up their target-date fund and never revisit it. They assume it will always match their goals.
Life and retirement plans often change. You might plan to retire at 65 when you start. Later, you could decide to work longer or retire earlier. Your original target-date fund might not match these new plans.
For instance, you could plan to retire at 70 instead of 65. In this case, you might need a different target-date fund to maintain growth longer.
- The Solution: Review your retirement goals regularly. Adjust your target-date fund if your plans change. Talk to a financial planner every few years. Update your fund whenever major changes occur in your retirement timeline.
- Example: An employee picked a 2045 target-date fund at age 30. They planned to retire at 65. Fifteen years later, they realized they would likely work until 70. So, they switched to a 2055 target-date fund. This change kept their investments focused on growth for a longer period and better matched their updated goals.
Not Selecting a Target-Date Fund
- The Problem: Some employees don’t choose a target-date fund, even when one is available. Instead, they often choose funds with higher recent returns.
While this may seem like a smart move, it can backfire. Target-date funds are diversified, balancing growth and stability over time. Other funds, like the S&P 500, may offer higher returns but come with more risk.
For example, an S&P 500 fund focuses only on U.S. large-cap stocks. It lacks the broader diversification of a target-date fund. This makes it riskier, especially during market downturns.
- The Solution: Choose a target-date fund that matches your planned retirement year. These funds are designed to adjust your investments as you approach retirement. They offer a diversified and structured approach.
- Example: An employee in their 40s picked a high-performing U.S. stock fund. They ignored the 2040 target-date fund option. When international markets outperformed the U.S. market, they missed out on potential gains. Later, they switched to the target-date fund. It offered better diversification and long-term growth.
Why Target-Date Funds Are Worth It
Target-date funds are a powerful tool for retirement planning. They offer:
- Ease of Use: You only need to pick the fund closest to your retirement year.
- Automatic Rebalancing: Your portfolio adjusts over time to meet your needs.
- Efficiency: They are professionally managed and optimized for performance.
Most employees find these funds reduce stress and save time. You can focus on your life—family, hobbies, or other priorities—while your investments work for you.
Final Thoughts
Avoiding these common mistakes can help you get the most out of your target-date fund.
- Use only one target-date fund to simplify your portfolio.
- Revisit your fund choice to ensure it matches your evolving goals.
- Trust target-date funds to provide a balanced approach. Avoid chasing returns with other funds.
At Plush Retirement, we help you make smart decisions for your future. Whether it’s selecting a target-date fund, asset protection, tax-free retirement, or optimizing your TRS pension plan, we’re here to guide you.
