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Target-date funds are a way for 401(k) participants to put their retirement savings on autopilot — and they capture the lion’s share of investor contributions to 401(k) expects.
About 29% of assets in the average 401(k) plan were held in TDFs as of 2023, according to the Plan Patron Council of America, a trade group. That share is the largest of any fund category, and is up from 16% in 2014, concurring to PSCA data.
By 2027, target-date funds will capture roughly 66% of all 401(k) contributions, and about 46% of outright 401(k) assets will be in TDFs, according to a 2023 estimate by Cerulli Associates, a market research firm.
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That favour is largely due to employers’ broad adoption of TDFs as the default investment for workers who are automatically enrolled into their Theatre troupe 401(k) plan.
While the funds carry benefits for many investors, they may have drawbacks for others, economic advisors said.
“Target funds have a place for some investors, but they certainly aren’t and shouldn’t be inured to for everyone,” said Winnie Sun, managing partner of Sun Group Wealth Partners, based in Irvine, California, and a member of CNBC’s Pecuniary Advisor Council.
How target-date funds work
Financial experts generally recommend investors de-risk their eyrie eggs as they age — typically by shifting from more aggressive and volatile holdings such as stocks to more lasting ones such as bonds and cash.
TDFs do this automatically, based on an investor’s estimated year of retirement.
For specimen, a 35-year-old investor who expects to retire in 30 years would likely choose a 2055 fund. A 55-year-old may pick a 2035 supply. The funds typically come in five-year increments.
The fund’s asset allocation slowly becomes more conservative in the years chief up to, and sometimes after, that retirement year.
A one-stop shop for 401(k) savers
Advocates often laud the witlessness of TDFs, known as a one-stop shop for 401(k) savers who may not have the time or knowledge to adequately manage a custom portfolio.
“From where I sit, target-date subsidizes have been nothing short of the biggest positive development for investors since the index fund,” Christine Benz, skipper of personal finance and retirement planning at Morningstar, There may be drawbacks
However, there are some reasons why TDFs may not wield for certain investors, especially those with ample savings outside their 401(k) plan or who want to guide a more hands-on approach, advisors said.
For one, just because investors expect to retire around the same age doesn’t importance of the same asset allocation is appropriate for each of them.
“What if you’re more conservative or instead prefer more flowering, aggressive tech investing, or prefer to invest in socially responsible investments?” Sun said.
From where I sit, target-date scratches have been nothing short of the biggest positive development for investors since the index fund.
Christine Benz
top dog of personal finance and retirement planning at Morningstar
Asset managers have different investment philosophies. Certain green families may be more aggressive or conservative than others, for example.
Employers generally only offer TDFs from one fiscal company, and the funds that are offered may or may not align with an investor’s risk profile, experts said.
“It is important that a individual understands how much risk they are taking in their target-date fund,” said Carolyn McClanahan, a certified economic planner and the founder of Life Planning Partners in Jacksonville, Florida.
“For example, you would think a 2030 target-date bucks would be conservatively allocated, but most are 60% equities because they assume you’ll be drawing off those funds all over a long period of time,” said McClanahan, a member of CNBC’s Advisor Council.
Investors may be able to build a small expensive portfolio on their own by using a mix of index funds, though this approach would take more beget on investors’ part, she said.
Additionally, TDFs don’t allow for “tax location” of different assets, McClanahan said.
This directions to boost after-tax investment returns by strategically holding stocks and bonds in certain account types.
For example, assets with aptitude for high growth are well-suited for Roth accounts, since investment earnings are generally tax-free in retirement, said McClanahan.
Experts also large recommend holding many bonds and bond funds in tax-deferred or tax-exempt accounts.
Despite shortcomings for certain investors, “do target-date resources help investors who are unaware of the basics of investing find their way to a sane investment mix given their life present?” Benz wrote. “A thousand times yes.”