The Risk of a Target Date Fund In Your Retirement Savings Account.

If your 401k plan has been amended to comply with the Pension Protection Act of 2006, which came into effect in January of 2008, you may find yourself as an investor in a Target Date Fund without having made that choice.

This product was designed as a one stop shop for employees to prevent them from getting stuck in the plan’s money market account which had been the default setting among your 401k options.

These mutual funds are designed to rebalance the portfolio toward more conservative assets, over time, as the employee approaches retirement. Sounds like a good idea; but, what is really happening?

Network Meetingphoto © 2006 Stevan Sheets | more info (via: Wylio)
OK, let’s look at the idea of “rebalancing.” Who does not want to be rebalanced?! Truly. If I find myself out of balance, I would love someone to help me get back to center. I have many friends I call upon when I am troubled and need to get rebalanced. But how does that apply here? Once a year on the anniversary of the employees hire or calendar year end or on whatever annual date the fund has identified (Why not Cinco de Mayo or Boxing Day?!) the fund automatically sells some portion of the equity funds and buys bond funds.

How does this make any sense in terms of the condition of the stock market or the bond market or the expected direction of interest rates on some arbitrary annual date? The assumption being made is that the stock portion of the portfolio will always be more risky then the bond portion of the portfolio. This is the assumption… that bond funds are the safety net. Yet, this is not always the case.

Remember the previous discussion about bond funds vs bonds. A bond fund owner has no date when he or she is going to get back all their money. The risk an owner of a bond fund cannot escape is the interest rate risk. If interest rates are rising, bond prices are falling; and, too, the value of the bond funds.

So when you are looking at your retirement savings account, unless you make and election to the contrary, you will likely find yourself in a Target Date Fund

Want more?

Enjoy unlimited access to 7 short, video tutorials which will quickly take you step-by-step through this easy process. Videos range in length from 4 to 13 min. averaging about 10 min. Just click here.