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Misusing Target Date Funds Can Lower Returns

| December 15, 2014

Target Date Funds are the default choice for many 401(k) savers. Proof that more Americans are gravitating toward the “set it and forget it” mentality can be found in a recent Reuters article revealing target date fund assets have soared to $624 billion.

But when it comes to how Target Date Funds should be used, some workers are confused. Also called lifestyle funds, target date funds include specific asset allocations suited to the year in which a worker plans to retire. The two biggest mistakes 401(k) savers make is being partial target date fund users and not asking for help.

Getting advice from a professional

According to a study, “Help in Defined Contribution Plans: 2006 through 2012,” 401(k) participants who receive investment advice from professionals have a 3.32 percent higher return than those who managed their own accounts. Even people who just sought out online investment advice from professionals had higher median annual returns.

Using the all-in-one solution properly

Target Date Funds are meant to be simple, all-in-one solutions for retirement savings. The allocations shift as a person gets closer to his or her retirement date. Although a professional may know how to mix Target Date Funds with other individual stocks or mutual funds, most individual investors get the allocation wrong. The study found people who were partially allocated to target date funds had returns 2.61 lower than managed accounts.

Target date misuse can hurt investment returns because the overall 401(k) portfolio no longer has the proper asset balance. Some workers are averse to using just one fund. Others want to time the market or buy too much company stock. A financial professional is often needed to repair the damage with advice on how to properly re-balance.