If you have a 401k plan, you probably have access to the increasingly popular option of a Target Date Fund (TDF). These funds offer a hands-off approach for investors, providing a diversified portfolio that adjusts over time. While TDFs are essentially the “easy button” for investors, it is important to understand how they work and the key differences between one TDF fund vs another, even though they may look identical to most investors and plan participants.
In this article, we will explore what a target date fund is, the percentage of people who use them, the concept of glidepaths, and the difference between “to” and “through” target date funds.
What is a Target Date Fund?
A target date fund is a type of mutual fund designed to provide a comprehensive investment strategy based on an investor’s intended retirement date. The fund’s name usually includes the target retirement year, such as “2050 Target Date Fund.” As the investor approaches their retirement date, the fund’s asset allocation gradually shifts, becoming more conservative by reducing exposure to higher-risk assets like stocks and increasing exposure to more stable assets like bonds.
Percentage of People Using Target Date Funds
Target date funds have become increasingly popular, particularly in retirement-focused investment accounts like 401(k)s and Individual Retirement Accounts (IRAs). According to the chart below surveyed by the Investment Company Institute (ICI), in 2019, 86.7% of 401(k) plans offered target date funds as an investment option. Among participants in these plans, 60.2% held target date funds, making them one of the most widely used default investment options. TDFs made up of 31.3% of total assets which is due to the fact this has become more popular by younger participants entering the 401(k) plan.
Understanding the Glidepath
The “glidepath” is a crucial concept associated with target date funds. It refers to the predetermined asset allocation mix and its changes over time. The glidepath typically spans from the fund’s inception until the target retirement year.
Early on, when retirement is distant, target date funds have a more aggressive allocation, with a higher proportion of equities. This allocation is meant to maximize growth potential over the long term, as younger investors have more time to recover from potential market downturns. As the target date approaches, the fund’s allocation gradually shifts towards a more conservative approach to protect accumulated wealth and minimize potential losses.
The glidepath is not uniform across all target date funds; it varies based on the fund provider’s philosophy and the specific needs of its target investors. Some funds have a steeper glidepath, meaning the shift to a conservative allocation happens more rapidly, while others have a more gradual glidepath, maintaining a higher equity allocation for a more extended period.
“To” vs. “Through” Target Date Funds
One of the key distinctions among target date funds is whether they are “to” or “through” funds. The difference lies in how the funds manage their asset allocation after the target retirement year.
- “To” Target Date Funds: These funds assume that investors will withdraw their savings gradually after retirement. Therefore, the fund’s asset allocation becomes more conservative until the target retirement year but remains steady afterward. The focus shifts to preserving wealth rather than accumulating it. “To” funds are more suitable for investors who plan to move their money into other investment vehicles or spend it during retirement.
- “Through” Target Date Funds: In contrast, “through” funds continue to adjust their asset allocation even after the target retirement year. The glidepath extends beyond retirement, becoming more conservative over time to support investors throughout their retirement years. This approach is suitable for investors who expect to stay invested in the fund throughout retirement, as it ensures ongoing management and adaptation to market conditions.
Target date funds offer a simplified and convenient investment option for individuals planning for retirement. With a predefined glidepath that automatically adjusts asset allocation over time, investors can take advantage of a diversified portfolio tailored to their retirement needs. When choosing this option, it is important to know if you are investing in a “to” or “through” target date fund before making a decision. As always, seeking advice from a financial advisor can provide valuable insights and ensure that target date funds align with one’s overall retirement strategy.
Presented by the Financial Planning Committee of Lake Street, an SEC Registered Investment Adviser
The information contained herein constitutes general information and is not directed to, designed for, or individually tailored to, any particular investor or potential investor. This report is not intended to be a client-specific suitability analysis or recommendation, an offer to participate in any investment, or a recommendation to buy, hold or sell securities. Do not use this report as the sole basis for investment decisions. Do not select an asset class or investment product based on performance alone. Consider all relevant information, including your existing portfolio, investment objectives, risk tolerance, liquidity needs and investment time horizon. Diversification does not ensure a profit or guarantee against a loss. There is no assurance that any investment strategy will be successful. Investing involves risk and you may incur a profit or a loss.