Like many Americans, you’re probably saving for retirement through a defined contribution plan offered through your workplace, such as a 401(k) or 403(b) plan. Some employers are adding options that can help you use these plans more effectively. These include target-date funds (TDFs) and managed accounts. The information below can help you decide if these funds might be right for you.
Digging into target-date funds
Target-date funds have become quite common. In 2014, more than 70% of 401(k) plans included target-date funds in their investment lineup, according to research by the Employee Benefit Research Institute and the Investment Company Institute.
In part, this is likely because target-date funds are a “qualified default investment alternative,” or QDIA. This means that, if you don’t choose an investment for your retirement plan, your plan sponsor may default you into a TDF.
The manager of a target-date fund assembles a portfolio based on a retirement date—say 2040. The portfolios typically include a higher proportion of growth investments (such as stocks) when plan participants are younger, then shift to more-conservative investments (such as bonds) as their retirement age draws closer. This is often referred to as the glide path.
It’s designed to be a simple investment solution, says Michael Finke, dean and chief academic officer with the American College of Financial Services.
However, while target-date funds eliminate some investing decisions, you can’t be completely hands off. You’ll want to confirm that the investment philosophy matches your risk tolerance; even within target-date funds, investment approaches can vary. You’ll also want to monitor the fund’s performance, and keep an eye on fees and expenses, as even modest charges eat into retirement savings over time.
You’ll also need to know whether the fund takes you “to” or “through” retirement. Those that take you to retirement tend to become more conservative right at the point of retirement. Those designed to take you through retirement generally continue to become more conservative while you’re in retirement.
Remember, like all investments, it is possible to lose money in a target-date fund, and there are no guarantees that a fund will provide adequate retirement income.
The managed accounts option
In contrast to a target-date fund, a managed account is a service. You inform a financial professional hired by your employer or plan sponsor of the myriad factors that should guide your retirement saving strategy. They then assemble a portfolio that takes this information into account.
Unlike the TDF, these plans can account for personal risk tolerance, savings rate, retirement goals and other things that are unique to your situation. Like TDFs, managed accounts can be QDIAs.
The value of this customization may be “a function of how much you differ from the average employee,” Finke says. If you have a larger portfolio and a more complex financial situation, you may find more benefit from a personalized approach.
For instance, the managed account provider may monitor your portfolio and sell an investment that’s declined, offsetting the gains experienced by another investment, thus lowering your tax bill.
Additionally, just the fact that you’re more actively involved in your retirement planning may encourage you to save more.
Managed accounts can also be more flexible than TDFs, as they are more apt to adjust based on changing market conditions, rather than focusing on the fund’s glidepath
Of course, such personalized service comes at a cost. A 2014 report by the Government Accounting Office, “401(K) PLANS: Improvements Can Be Made to Better Protect Participants in Managed Accounts”, examined eight managed-account providers and found fees ranging from $8 to $100 on every $10,000 in participants’ accounts.
Moreover, it’s not always possible for providers of managed accounts to achieve the higher returns that would compensate for the higher fees, the GAO found.
What you can do next
Both target-date funds and managed accounts can be valuable tools as you save for retirement. Talk to your employer-sponsored retirement fund plan manager or personal financial advisor to help you determine which might be best for you.
Karen Kroll is an experienced freelance writer and editor, with a focus on corporate and consumer finance. Her articles have appeared in AARPBulletin.com, Bankrate.com, Business Finance, CFO, CreditCards.com, Global Finance, and many other publications.