Investors are struggling to guesstimate the effect of COVID-19 on the global and U.S. economies. The Federal Reserve rightly cut its benchmark interest rate by half a percentage point. Nevertheless, daily scraps of new information are sending money managers scrambling to reassess their outlook.
Question is, what should individual investors do, especially those saving for their retirement in a 401(k), 403(b) or comparable savings plan? Market timing is often hazardous to the wealth of the typical individual saver. Most of us don’t time the markets well.
Here is where a financial innovation is helping many savers stay the course with their asset allocation: Target-date funds. What financiers call innovations are usually nothing more than needlessly complex products with steep fees. But not always. Sometimes, a financial innovation can improve investing outcomes.
A target-date fund is a well-diversified portfolio that invests mostly in riskier but potentially higher-return equities when retirement is long off and automatically reduces your stock exposure the closer you get to your retirement date, typically at age 65. Target-date funds are usually offered in five-year increments. For example, someone who is 40 years old might buy a target-date fund for 2045.
Most employers with 401(k) plans now offer the option and for new employees it’s the most popular choice. One reason target-date funds have grown so much is legislation allows for the choice to be the default option in a retirement-savings plan. This means if you join a 401(k) but don’t pick an investment option, the employer can put your contributions into a target-date fund without worrying about liability.
Another reason for the popularity of target-date funds with 401(k) participants is it relieves employees of having to decide how much to put into stocks and bonds and when to change their percentages. The only decision you make is a reasonable guess of when you might retire.
That said, there are many flavors of target-date funds. Unfortunately, some come with too-high fees, often loaded with too many mutual fund flavors. Some funds may reach the target retirement date with a bigger exposure to equities than many near-retirees may like. Nevertheless, the embrace of low-fee, well-diversified target-date funds can pay off. You get a well-thought-out asset allocation strategy for the long haul and an investment that helps steer you away from making speculative bets.
Chris Farrell is senior economics contributor, “Marketplace”; economics commentator, Minnesota Public Radio.