Dear Dr. Don,
I recently became eligible for a 401(k) at my job. I chose a target-date fund. Do you recommend them, and can you change them once you sign up?
— Tom Targets
Target-date retirement funds are often the default choice for 401(k) plans because they recognize the need for diversification across asset classes, narrowly defined as stocks, bonds and cash. The funds change that asset allocation over time as you move toward the target date, typically your planned retirement date. When buying a target-date fund, you’ve delegated the asset allocation decision to the mutual fund manager.
Target-date funds are often seen as a “one-decision” investment, at least by the 401(k) plan participant. That makes them attractive to people who don’t want to spend time reviewing and revising their 401(k) holdings as they move through their careers, contributing to this account. By and large, investment professionals will tell you there’s no such thing as a one-decision investment, and they’re right.
There’s been a lot of discussion in the industry about whether target-date retirement funds pursue appropriate asset-allocation strategies as they move through time toward that target date. You definitely want to read the fund’s prospectus to learn about the allocation approach that the fund takes toward the target date so you understand the investment goals of the fund, and to make sure they align with your investment goals.
Target-date funds are typically a blend of a mutual fund family’s funds. It’s the percentage of your investments allocated to each of these funds that changes over time as you approach the fund’s target date. It’s important to review both of the funds used as well as the annual fees and expenses associated with investing in a target-date fund to make sure you’re comfortable with them.
I’d say that a target-date fund isn’t a bad place to start accumulating wealth in your 401(k) plan, but you shouldn’t view it as a “one-decision” investment. After accumulating $10,000 or more in the account, you should revisit the decision to invest in it. You have the ability to move your money to other funds within the 401(k) plan. It’s typically very easy to do, and you can often do it online.
What I recommend for people starting out in a retirement investment account is they concentrate their investments in diversified mutual funds rather than trying to diversify on their own by investing in mutual funds with a narrow investment objective. Target-date funds work toward this objective. There are other paths you can pursue if you choose.
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