The financial industry figured out how to improve saving before retirement, and 401(k) investors are taking advantage.
The idea is simple: create an investment choice that allows you to “set it and forget it” until you retire. These options available in a 401(k) plan are called target date funds (TDF). If you elect a TDF when you’re young, the fund automatically recalibrates as you age, becoming more conservative as you near retirement. In that way, the fund captures growth and is less likely to experience severe setbacks from market downturns as you approach retirement.
An article in the San Francisco Chronicle says Vanguard reported that just over half of participants in the 401(k) plans it administers are invested in a single target date fund. These funds account for one-third of the assets in all 401(k) and other defined contribution plans run by Vanguard.
The article points out that the popularity of target date funds surged after 2006, when the U.S. Department of Labor allowed employers to automatically enroll employees in 401(k) plans and automatically increase their savings rate each year, unless the employee opts out.
Saving vs. retiring
Saving for retirement is important. As I often preach, however, pre-retirement is only half your plan. The most important half may come after you retire. Not only might you spend as much time in retirement as you did saving for retirement, the risk of a misstep is far more serious.
“Set it and forget it” is a good approach for your retirement years, too.
Like target date funds, an Income Allocation Plan automatically becomes more conservative as you near your second retirement age – the time you should retire all of your risks.
That goes a long way toward not only providing better and less worrisome results but could also encourage people to save more, especially if common-sense income allocation were made a default option for 401(k) plans. Failing that, you’ll have to roll out your savings to a rollover IRA and execute an Income Allocation Plan on your own.