Well, technically speaking the word popularity might be stretching it, at least in the way it is usually connoted. But, there is no denting that more and more people are utilizing target-date funds as investment vehicle inside of 401Ks. However, a huge reason for that is that many companies use those funds as automatic “choices” for employees. So, unless you sit down and research your fund choices and decide on something different then you are going to own them whether you want to or not. That is even if you notice of course. There are no doubt many investors that have no idea what a target-date fund is or that they own one. But one thing is certain and that is that the option is a huge part of the 401K universe:
Target-date funds are growing fast: Fully one-third of workers at the end of the third quarter had invested all of their 401(k) assets into a target-date fund, up from 3% who did that a decade ago, according to Fidelity’s data.
Whoa. That is really rather astounding. It really goes to show you how few people are really all that interested in investing. While there is a place for these funds, they are hardly a panacea, and with just a bit of research almost every 401K plan assuredly has some intriguing alternatives to them. Target-date funds are not known for their performance (that can change as time goes on, of course) and further, they are both more and less conservative than many people perceive them to be. Many older employees may be vastly over weighted in bonds without fully realizing it. Furthermore, those bonds may not be quite as “safe” as some people think. Many new investors may be surprised how far bond prices can fall. Admittedly, the funds tend to shorten duration as one gets older, but even a 10 year bond can get hit pretty hard. The other side of the coin is that younger people (young in the 401K sense) may be in much more conservative funds than they really want or need to be. Again, these funds are usually managed extremely conservatively so as to minimize any surprises. There are options that are more aggressive, but generally speaking, other fund choices are probably better fits. And young people are naturally the one that find these fund options the most appealing:
And a whopping 55% of younger folks aged 22 to 34 are investing all of their 401(k) money into such funds. Target-date funds are a one-stop-shop product—you invest in one mutual fund, and the manager handles the task of determining your asset allocation and rebalancing. But, as with everything, it’s caveat emptor.
That is incredible, if not necessarily surprising. And there are certainly great reason to choose a target-date fund, most especially for the automatic rebalancing feature. But, younger investors often don’t really need this feature, or at least need it much less. And there is no mystery why this is happening:
About one quarter of the plans covered by Fidelity use auto-enrollment, but that jumps to about 50% for large companies. Almost all of the companies that have an auto-enroll plan use target-date funds for that feature.
It’s really that simple and there are no devils here. Companies want their employees to have a successful plan, but they also really, really don’t want to get sued. These target-date funds fit the bill. And, lets’ also not kid ourselves on the other side of the equation. People like these funds because they provide an easy, hands-off method of investing. All of that being said, it is still quite amazing the parabolic growth of the investment vehicles. There are certainly advantages to them, but it is not much of a stretch to declare that they might be overused. I’ll get more in depth on these target-date funds in my very next post, so stay tuned!