The past week has seen volatility creep back into the stock market. The market had lost 10% from its peak during the week. After a long run of positive returns, investors now have to ponder how much risk is too much.
Impact on 401ks?
Investors checking their 401ks closely over the past week or two likely saw a decrease in their balance. Some may have seen more substantial decreases than they were expecting. These decreases are likely due to how the account is invested. Those invested more heavily in stocks would see larger losses than those with more conservative investments. However, many 401k participants use the default investment option for the plan, which typically is a target retirement date fund. Target retirement date funds are a single investment designed to balance out your investment portfolio with the right mix of stocks, bonds, and cash to get you to retirement and through retirement. You pick your retirement year (say 2025, 2030, etc.), and the fund does the rest. But what some investors may have realized this past week is that these funds can have a big difference in the amount of risk they take.
2025 Retirement Funds – 5 years out
Let us look at the 2025 target retirement funds. These funds are designed for those looking to retire in the next five years. Some investors may assume the funds are designed to be fairly conservative to avoid large losses only five years from retirement. However, the fund is working in getting you into retirement and through retirement, which could be 30 years or longer.
How Big Are The Differences?
We can look at the five largest fund families in the target retirement date space to see how they invest their 2025 date funds. Of the five funds, the lowest allocation to stocks was 50%, and the highest was 65% stocks. Many may be surprised to know that all five funds had at least 50% or more invested in stocks, and some were approaching 2/3 of their investments in stocks. That is a wide difference in risk for funds, all targeting the same retirement date.
These funds have continued to increase the amount targeted to stocks to help offset the longer lifespans of retirees. If you are investing for a 25 to 30-year timeframe or longer, you need a sizeable allocation to stocks to help offset inflation, spending needs, healthcare costs, etc. However, in trying to create a simple investment decision for investors (pick your retirement year), it may be confusing to know that the fund is investing for a much longer period. Those believing the fund is going to protect your balance as your approach retirement may be surprised to know that a sharp move down in stocks may be very impactful to a fund designed for a near term retirement.
What Should You Do?
Target retirement date funds can be great investments, but it is essential to know that they are designed as long-term investments with significant allocations to stocks. For those using these funds and nearing retirement, one easy step is to log in to your 401k, click on the target retirement date fund you are using, and see how much is invested in stocks. All of these funds will either show you a pie chart or percentage break down of the amount in stocks, bonds, and cash. Make sure this allocation lines up with your risk level and expectations. If it does not, there will be other choices available that will align more closely with your comfort level.
It is important to understand that target retirement date funds are not designed to get you to retirement. They are invested in getting you through retirement, which is a different strategy. Being aware of this difference can save you a lot of angst and pain if you are not comfortable with a lot of stock risk as you approach retirement.
Please remember that past performance may not be indicative of future results. Prior to implementing any investment strategy referenced in this article, either directly or indirectly, please discuss with your investment advisor to determine its applicability. Any corresponding discussion with a Bedel Financial Consulting, Inc. associate pertaining to this article does not serve as personalized investment advice and should not be considered as such.
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