While many employers offer retirement accounts as an employee benefit — even those that offer generous matching contributions — many do not offer adequate education on how to choose among the investments offered in the retirement plan. If you have engaged a financial professional to advise you, make sure that their advice about your overall investment strategy incorporates the money in your (and your spouse’s) retirement accounts. If you don’t have a financial advisor and don’t have the time to educate yourself about investments, Target Date Funds (TDFs) may be a reasonable alternative if you do a bit of research yourself. Here are the basics of what you need to know:
Employer Sponsored Retirement Account Basics
If you are employed and eligible to contribute to your employer sponsored retirement plan, congratulations! Your employer is giving you the opportunity to contribute much more than the IRS maximum allowable contribution amount for Individual Retirement Accounts (IRA). Maximum contribution to a company retirement account in 2017 is $18,000 ($6,000 more if you are over 50 years old) compared with $6,500 to an IRA. And, your employer may match some of your contribution. That’s free money and worth a conversation with your employer to find out if you are eligible to contribute, as well as determine if you are taking full advantage of this opportunity.
Contributing to an employer sponsored retirement plan also requires choosing among the several investments offered by most plans. Investment choices are typically mutual funds and there may be many dozens from which to choose. Unless you are an experienced investor or have help from someone who is, deciding what funds to invest in and when to make changes bewilders most employees. If your employer offers employee education, it will be time well spent; and, if you are an employee who has a financial advisor, make sure to ask for help with retirement plan investments — something many advisors overlook. If none of these options apply to you, consider TDFs.
Target Date Funds
TDFs automatically spread an employee’s contribution among a mix of mutual funds that hold stocks, bonds and cash in proportions targeting a specific year of retirement. About ten years ago, the U.S. Department of Labor began allowing the use of TDFs in retirement accounts. TDFs alter the mix of stocks, bonds and cash, by reducing the percentage held in stocks and shifting the allocation toward more conservative investments the closer you are to retirement.
TDFs aren’t managed by the investor, who may make panicked decisions during turbulent markets that they may later regret. But, not all TDFs are alike. Before investing in a TDF, it is important to understand how it invests and adjusts its mix of stock, bonds and cash over time as well as what the TDF costs.
TDF Glide Path, Costs and Other Investments
Glide path is the name TDFs give to the timing of changes in the mix of investments as the years pass toward the targeted retirement, analogous to an airplane moving through take off and voyage to landing. Some TDFs have a glide path that move entirely to cash at the target date, others continue to hold a significant amount of stock through the early retirement years or even through the entire retirement. Because the percentage of stock in an account is a major factor in how an account will perform during market up and down times, it is important to know and be comfortable with a TDF glide path before investing in it.
Some employees have not only an employer sponsored retirement account, but also a spouse’s employer retirement account and perhaps other investment accounts. If you choose a TDF, check whether its mix of stocks, bonds and cash is consistent with the investment strategy in your other accounts.
Investing in a TDF costs more than putting money in individual mutual fund choices offered through an employer sponsored retirement plan. TDFs offer the additional service of choosing the funds and adjusting the stocks, bonds and cash mix, so some additional charge is justifiable. However, some TDFs add more than 1 percent per year to the other costs of the retirement plan and can be a major drag on performance.
As always, when you have questions about important financial matters, consult your trusted financial advisor.
Investments in target date 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 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.
Samuel Financial LLC is located at 858 Washington Street, Dedham, MA 02026 and can be reached at 781.461.6886. Securities and advisory services offered through Commonwealth Financial Network, member FINRA/SIPC, a registered investment adviser.