Opinion: Target-date funds are showing why they can shine when inflation and economic uncertainty is high

Rising inflation and the sharpest increase in US interest rates since 1994 have contributed to a widespread sense of unease as many retirement fund participants watch their savings dissolve.

Uncertainty is an ideal market environment for investors to consider how a target-date fund — equipped with professional management and low maintenance — might fit into their retirement plan. About 40 million Americans currently use target-date funds as a savings vehicle. While many employees end up contributing to a target-date fund because it’s the default option of their 401(k) plans, others consciously select it as a comprehensive strategy to managing retirement savings while rebalancing risk.

What many employers and employees don’t realize is that to choose the best target-date fund based on retirement goals, it’s important to have a savvy plan sponsor and/or portfolio manager for guidance. Not every fund is created equal, as each varies in quality and composition, so looking under the hood for specifics can help employers decide which ones to offer, while putting employees in the best position to maximize their savings. Target-date funds may not be the best choice for every investor, but increasingly personalized glidepaths make them an attractive option.

The mix of asset classes found within target-date funds help limit the effects of market volatility.

Target-date funds have a risk posture that changes over time to match career trajectories, capitalizing on an individual’s highest-earning years to create a bigger nest egg. This so-called “lifecycle fund” considers one’s age and retirement date so risk and return can be balanced appropriately. The mix of asset classes found within target-date funds help limit the effects of market volatility. More than other investment strategies, target-date funds have the diversity and consistent upward movement to make investors feel comfortable in any kind of market — including one challenged by inflation and a looming recession. Participants should feel more inclined to stay invested, rather than risk a poorly timed exit that sacrifices positive long-term returns.

A common criticism is target-date funds lack the personalization or customization of other options. While this may have been true when first introduced, there are now many target-date fund solutions for a range of situations. Information on demographics, risk behaviors, deferral rates, account balances and existing investments can ensure individuals are matched with the ideal risk posture or “glidepath.” Most target-date funds are still equity-heavy, but less-aggressive ones have emerged. Plan sponsors and participants have more options for personalization than ever before.

Different demographics require different funds

Since employees must choose from whichever investments their employer offers, it’s important for plan sponsors to invest time in selecting the right ones for a workforce. The goal is to ensure that even unsophisticated investors have a diversified portfolio which will allow them their anticipated post-retirement lifestyle. Plan sponsors and advisers must be diligent about analyzing the available data to make informed decisions on behalf of employees, so that workers can choose the right target-date fund to meet their retirement goals.

It can be tempting to go with brand-name funds, but just because something is recognizable doesn’t mean it’s the best choice with the most appropriate risk. A close look at underlying asset allocations might reveal less-than-satisfactory details. Further, not all target-date funds have a retirement income piece, something that can be valuable when contributions are no longer being made. A fund’s makeup and risk posture matter.

Educate employees about retirement planning

Regardless of whether plan sponsors choose target-date funds or an alternative, such as index funds, they should educate employees about their options. Engaging plan participants can empower them to make more informed decisions about which glidepath meets their personal circumstances. Providing glidepath options is a positive step towards better retirement benefits, but must include an education component. By expanding financial literacy, employers can demonstrate respect for their workforce and give them control over their futures, which can improve employee satisfaction and retention.

Clearly communicating the options available may also help sophisticated investors decide how they want to manage their assets. For high-net-worth individuals or those with a strong investing background, investing in target-date funds might make less sense because target-date funds don’t consider other assets, and may leave an investor overexposed to stocks or bonds. A professional financial adviser can be valuable for figuring an appropriate allocation and deciding when to introduce additional diversification.

A carefully vetted target-date fund is the best way to save for retirement for many investors. Built-in portfolio diversity makes them reliable long-term investment tools. Multiple glidepaths allow for increased customization, provided plan participants receive the resources needed to select the appropriate one. Both employers and employees should consider the benefits of target-date funds as a retirement option as long as their specific retirement goals are aligned with the fund profile, and thorough research is part of the fund selection process.

Nick Della Vedova is a president at NRP Retirement, working with clients on complex retirement solutions. Jeff Elvander is chief investment officer at NFP Retirement and has 30 years of professional investing experience.

More: Are you in the retirement ‘risk zone’? These investments might be able to protect you.

So read: The Fed vowed to crush inflation with higher rates. Then the stock market rallied. Here’s why. (It’s not good news.)

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