Target-date funds are now the most popular investment vehicle for 401(k) contribution. Find out why choosing the wrong fund can cost you dearly.
More than half of all 401(k) contributions now go into target-date funds, Bloomberg Business reports.
This year marks the first time that has happened, and the trend is projected to continue, with 88 percent of all 401(k) contributions going into target-date funds by 2019.
Target-date funds, or TDFs, are a type of mutual fund geared toward people with less investing expertise, or who simply do not want the hassle of rebalancing their investments.
Here’s how Money Talks News founder Stacy Johnson describes TDFs in “Why You’re Stressed About Your 401(k) — and How to Get Over It“:
These popular mutual funds are appealing because they take a lot of the work out of investing. You choose the date when you want to retire — 2030, for example — and the fund is supposed to do the rest, rebalancing your investments periodically to meet your goals.
Target-date funds appear to be doing well for the millions of Americans who are now invested in them, Bloomberg reports. TDFs have been around for a decade and have returned an estimated average of 5 percent per year over that decade. That is a typical return for a fund that blends stocks and bonds, according to the Bloomberg report.
Target-date funds are also saving investors from themselves, an advantage over other types of mutual funds. Bloomberg reports:
The average mutual fund has a flaw, which is that the average investor hardly ever does as well as his or her funds. Investors tend to jump in and out of funds at the wrong time…
Investors in target-date funds, at least so far, seem to have avoided this curse. They’ve been sticking with their funds and doing surprisingly well in the process.
Target-date funds aren’t perfect, though.
“Target-date funds are conceptually simple, but there are few constraints on how they have to be designed, so you end up with lots of different approaches,” Boston College finance professor Jonathan M. Reuter told The New York Times earlier this year.
A study by Reuter and a colleague found a wide range of returns and risks across funds for the same retirement year.
When the stock market crashed in 2008, for example, an Oppenheimer fund for 2010 retirees fell by 41 percent, while a Wells Fargo fund for 2010 retirees fell by only 11 percent.
Fees for target-date funds can also be high, from 0.17 percent for Vanguard’s TDFs to more than 1 percent for more than a dozen TDF funds at other providers.
To learn more about mutual funds, check out “Ask Stacy: How Do I Invest in a Mutual Fund?”
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