WTNZ Fox43 Knoxville, TN-How to know if your 401k target date fund is appropriate?

How to know if your 401k target date fund is appropriate?

By Dr. Douglas Rice
Provided by

Target date funds change automatically as time goes by, making them more conservative as you get older. This may seem like a great idea, but there some things you should consider before jumping on the bandwagon.

Are you average?

The target date funds have investors pick the fund based on when they want to retire. But that’s about all they know about you. Issues like withdrawal rate, savings rate and risk tolerance are all based on averages. This means that target date funds may not be appropriate for those that aren’t average or don’t want to be average.

Do you want to use a hands off approach?

You'll need to be willing to accept whatever result occurs. The advantage of target date funds is that they reduce your exposure to risky assets, namely stocks, on a regular basis as you age. That way when you get to retirement you aren’t holding too many volatile stocks that could tank your retirement quickly.

However, just because you aren’t thinking about adjusting your asset allocation every year doesn’t mean that this strategy will work out best for you. While the idea of being hands off is appealing to busy investors, not being involved doesn’t increase your chances of accomplishing your goals. "Out of sight, out of mind" isn’t typically considered a solid strategy with your money.

Do you know what’s in the fund itself?

Target date funds aren’t all created equal. They may be more or less risky than you would like. From the point of view of those who sell the funds, it could be advantageous, prior to the recent market fall, to tout potentially higher returns. Who doesn’t like the idea of making more money? But those expectations of higher returns are because there is also higher risk.

Do you know the risks?

When the market turned down, bond funds didn't do well either, which made them less than the safe haven many were led to believe. The risk of each fund will be different. If you want to find out what's actually in the target date fund you have available to you in your 401k, you have to do your homework by reviewing the fund's prospectus and other information. This can usually be found on their website. As with any investment, if you don't understand it, avoid it

Do you want a guarantee at retirement?

Many people are misled into believing that all target date funds provide some sort of guarantee at retirement, somewhat like Social Security. But that's not usually the case with target date funds. So once again, some research on your part will provide the answer in your specific situation.

How do you feel about fees?

Many target date funds are funds of funds, meaning that you aren't investing directly into a mutual fund, but a fund that invests in mutual funds for you. So you may be paying a fee to the target date fund, and then paying another fee to the funds inside the target date fund. That can be quite a cost given the limited services provided.

Target date funds are a case where the idea is more appealing without the details. But when it concerns your money, the details are what matter.

Dr. Douglas Rice helps individuals about financial matters in a variety of ways. In addition to his financial advisory practice, he also writes, speaks, and conducts seminars about money and financial planning topics. To learn more, start with his blog, Taking Risks and Reaping Rewards, at douglasrice.com. There you can collect your free copy of one of his books, Reflections on Conventional Wisdom. Also, you can follow him on twitter @drdouglasrice.

Read the original family finance article on FiLife: http://www.filife.com/stories/how-do-you-know-if-your-401k-target-date-fund-is-appropriate

FiLife Family Finance Community © 2009 FiLife