Target Date Funds: The Essential Guide
Because not all target date funds are created equal...
If there is one thing that's clear from recent history, it's that not all target date funds are created equal. But that's good. It means you have choices - provided you understand the differences so that you can choose the target date fund that is aligned with your goals.
But how do you start? We believe there are four core components of a target date fund that you need to understand before you make your selection. After all, the fund you choose can make a big difference to your participants.
The three key decisions in building the glidepath are the equity percentage for the longest-dated funds, the final equity landing point, and the rate at which the equity percentage declines. The glidepath also needs to take into consideration participants' need for future growth and tolerance for volatility during retirement. The target date in the name of the fund is the approximate date an investor plans to start withdrawing money.
Putting the objective into action
Consider our 45-year old participant. At 25, she had little invested in her 401(k) and had many years ahead of her to absorb market volatility. At 65, she will have accumulated the bulk of her savings and will soon begin to draw on her savings for income. Your target date fund has to meet your vision for her at every stage of her career.
Selecting the glidepath
The glidepath maps the mix of asset classes that will bring her from the start of her career into retirement.
Key questions to consider:
- How high should the equity percentage be at the beginning, and how low should it be at the landing point?
- At what rate should fixed income and inflation-fighting asset classes replace equities as the fund ages to maturity?
- How will your glidepath help participants turn their accumulated savings into food, shelter and living expenses in retirement?
Your glidepath needs to achieve your fund objective and shapes your participants' experience along the way.