Benefits of Using Target Date Funds in 401k in Times like These

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Target date funds are great resources for 401k participants of any age. They are particularly useful if you don’t have a good understanding of investments or are knowledgeable but wish your portfolio to be managed (on “autopilot”). These funds have dates in their name that are used to determine your projected retirement age. For example, if you are 25 years old and plan to retire at 65 then you would look at the target date 2040 fund. Here’s how they work and their benefits.

We will use basic numbers to try and simplify it. Suppose your 401k balance is $10,000 and you are in a 2040 target date fund. A 2040 will be 80% stocks (higher risk, higher return) and 20% bonds (low risk, low return). That means $8,000 is in stocks and $2,000 in bonds. If the stock market falls and is down for a period of time like during the COVID-19 pandemic, the value of the fund will fall. If the fund fell to $8,000 then you might have $6,000 in stock (due to the stock market decline) and $2,000 in bonds (due to the stability of bonds).

It is a good time to buy when the market is down. By maintaining an 80/20 ratio, these funds will shift you back to that ratio from a 75/25 ratio you are in now. $400 would be shifted from bonds to stocks.

This concept can be compared to a portfolio of 80% in one stock fund and 20% in a bond fund. In the same scenario, the market causes the stocks to fall to $6,000. You could sell $400 worth of the bond fund and buy $400 worth of the stock fund, but you’d have to do this yourself and know when to do it. The benefit of the target date fund is that it “adjusts” automatically.

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Investments in target date or target retirement funds are subject to the risks of their underlying holdings. The year in the fund name refers to the approximate year (the target date) when an investor in the fund would retire and leave the workforce. The fund will gradually shift its emphasis from more aggressive investments to more conservative investments based on its respective target date. The performance of an investment in a target date or target retirement fund is not guaranteed at any time, including on or after the target date, and investors may incur a loss. Target date and target retirement funds are based on an estimated retirement age of approximately 65. Investors who choose to retire earlier or later than the target date may wish to consider a fund with an asset allocation more appropriate to their time horizon and risk tolerance