Target-date retirement funds can be a 'no-brainer,' says Morningstar strategist: How to know if one's right for you

"Plan sponsors have gotten a lot better about picking high-quality funds from reputable firms."


Many people have some responsibility that requires too much mental energy and that they're willing to pay someone else to do. For some 40 million Americans who invest in target-date funds, one of the chores they outsource is the occasionally tedious business of managing a portfolio for retirement.

These funds are meant to be the sole holding in your retirement account and function as all-in-one portfolios. That's because they hold a mix of stock and bond mutual funds that professional money managers tweak to grow more conservative as you near the date you intend to retire.

"These funds are made for a one-size-fits-all approach," says Todd Rosenbluth, head of ETF and mutual fund research at CFRA. That means they'll follow a strategy that works for most people.

And if you're a hands-off investor, especially one who is earning a matching contribution from an employer in a retirement plan, that may be just what the doctor ordered, says Jason Kephart, a strategist at Morningstar specializing in multi-asset manager research. "It's a no-brainer for people who don't want to do their own investing or worry about regularly rebalancing their portfolios."

Still, before investing in one, it's smart to make sure the fund you're buying fits you, too. Here's what to look for.

Target-date funds are especially smart if you get a company match

Target-date funds owe much of their popularity to their prevalence among mutual fund rosters in workplace retirement accounts, where they are often the default investment. If you're uninterested in managing a retirement portfolio, choosing this option can be a good move, says Kephart.

"It's an especially good move if you're getting a company match," he says, with the caveat that you'd be wise to think twice before investing in a substandard fund.

By that Kephart means a target-date fund from an obscure fund company that could charge high fees and hold funds with poor track records. "If you don't recognize the name of the firm, I'd be a little concerned and want to investigate the fund," he says. "But for the most part these days, plan sponsors have gotten a lot better about picking high-quality funds from reputable firms."

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How to choose a target-date fund in an individual account

If you want to invest in a target-date fund in an account that you control, such as an IRA, you have hundreds of options to choose from — not just the family of funds on the menu in your 401(k). Here's how experts suggest narrowing down options to find the fund that's best for you.

Consider investment costs

"The only thing you can really control when it comes to investing is how much you pay to get in," says Kephart. "The lower the fees you pay to buy and own an investment, the more of the returns you get to keep."

Since target-date funds pass the management fees of the underlying funds in their portfolio along to investors, target-dates that hold index funds will typically come with lower expense ratios than portfolios constructed from funds helmed by active managers.

But which fund will be cheapest for you, personally, comes down to where you invest. While brokerages will typically offer you the funds that they sponsor for free, they may charge you a transaction fee to buy shares in a rival brokerage's fund. "Those kinds of up-front commissions can take a big bite out of your earnings potential," says Kephart. "Especially if you're investing small amounts of money at a time."

You'd be wise to pay attention to which share class of a fund you're buying. While a certain fund may come free if you were able to hold it in your 401(k), the share class available through your brokerage account, such as "class A" shares, may come with a front-end sales charge (also known as a "load") when you invest.

Review the fund holdings

Even though two target-date funds may be geared for people intending to retire in the same year, the underlying portfolios and investment strategies can differ wildly. Experts recommend taking some time to see which fund aligns with the way you want to invest. Funds that invest in a higher percentage of stock for longer are considered more aggressive and theoretically offer a higher potential return along with a bumpier ride for investors over time.

Within the mix of stock and bond funds, many target date funds will further diversify, for instance by holding a mix of large, small, and medium-size stocks, and by holding funds that focus on U.S. stocks as well as firms in developed foreign economies and in emerging markets.

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"If you're buying one of these funds, you need to ask yourself if that mix of asset classes makes sense to you based on your risk tolerance, and, say, your confidence in international investing," says Rosenbluth.

While you're at it, check on the longer-term performance of any fund you're considering (or a version of it that's closer to the retirement date), but don't just pick the one with the highest return, says Rosenbluth. "If you're looking at three, five, 10 years, funds with the most equity exposure are likely to be the strongest performers given how the market has done," he says. "Those are also likely the riskiest. Make sure you're comfortable with how some of these funds have performed in past bear markets."

Monitor your fund based on your tolerance for risk

Making sure that your target-date investment aligns with your tolerance for risk is essential for making sure that you're going to sit back and let the pros do their job. If you're just starting out, most target-date funds are going to be invested almost entirely in stocks. But as you get closer to your retirement date, different funds' strategies will diverge widely as they shift the portfolio toward a majority in bonds.

Checking in regularly to make sure you're comfortable with your portfolio mix can help you avoid big surprises, says Rosenbluth. "People tend to forget about their portfolios when things are humming along, and then they check back at the worst times — when things are down," he says. Adjusting your target-date fund to align with your risk tolerance may mean moving to a version of the fund with a sooner or later retirement date. That goes for aggressive and conservative investors.

"I have about 20 years until I retire, which would put me at a more balanced exposure between equities and bonds than someone younger," Rosenbluth says. "But because I'm knowledgeable about the stock market and the risks I'm taking in equities, I might be more comfortable in a fund with a longer time horizon."

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