Target Fund: Glide To or Glide Through
November 22, 2010I heard a statistic the other day that the average employee spends 30 minutes choosing their benefits at open enrollment. I cringe to think how some people choose the funds in their 401(k) plans and I’ve seen the resulting disaster from people choosing the wrong funds especially funds they thought were safe and turned out to be much more aggressive than they thought. Many of these were Target Funds.
Target funds have been under scrutiny lately because of the losses they incurred at the end of 2008 when the market dropped. Employees close to retirement thought since they picked a fund that had a target of 2010, that it would be very conservative and when their funds dropped 40% right before they were ready to retire, many people were shocked. They had no idea their investment mix was so aggressive.
Target funds aren’t necessarily bad, but like any investment, you need to understand what you have. There are two things you need to know about a target fund before you choose to invest in it. First you need to find out if it is a “glide to” or “glide through” target fund? Many people thought they had one and they actually had the other. You also need to know the allocation of the fund and make sure it is a fit for both your time frame and your investment temperament – your risk tolerance.
First let’s define “glide” –
The fund gets more conservative as you get closer to the date. The glide is the changing of the mix of investments moving a higher percentage out of equities to bonds and cash equivalents as you near your goal.
Glide to – retirement is the target the fund glides to. When you plan to retire at 65 and your target glides to 65.
Glide through – your retirement date maybe 65 but this target date assumes your life expectancy at age 85 so your funds may still have a high percentage of equities at 65 i.e. this kind is riskier.
The danger is if someone thinks their fund is a “glide to” 65 and it’s a “glide through” to age 85, the funds are probably much more aggressive than they thought – not an ideal thing to find out on your retirement date right when the market happens to drop.
The second test of the target fund is to see if the mix of investments matches your risk tolerance no matter what your age. Many of the funds with target dates 20 years out have 90% in stocks. The theory being that you will have greater gains over time since equities have historically outperformed bonds and cash. If you feel that is too aggressive a mix for you, consider checking the mix of investments in other target funds and choose one with a closer target date that reflects your own risk tolerance a bit more.
Remember to always look at both the target date and the mix of investments and if they are both right, you’ve found the right one. If not, modify. Armed with this information, you should be able to pick your fund in much less time allowing you to spend a little more time on some of your other employee benefits and possibility saving an extra dollar or two because of it.