Are you one of the millions of Americans who have invested some of their 401(k) plan money in target date funds? If so, perhaps you should take a closer look at what is inside the fund.

That’s the conclusion of Ron Surz, a pension consultant and long-time critic of these funds, because of the risks they present to those in or close to retirement. He calls target date funds “a bomb waiting to be detonated by the next market correction.”

The concept of target date funds has long been appealing to 401(k) plan participants: Just choose your presumed year of retirement and let the “pros” decide how much money you should have in stocks vs. bonds, and which categories of stocks should be included. This system is supposed to give peace of mind, despite the ups and downs of the markets.

In fact, many companies use target date funds as the “default” option when employees sign up for the 401(k) plan, calling them a safe and efficient way for inexperienced investors to build a retirement account. As a result, there is now more than $3 trillion of retirement money invested in target date funds.

Here’s how they work:
In a target date fund, the percentage mix of stock and bond exposure changes to become supposedly more conservative as you near retirement. But not all target date funds have the same allocation percentages.

For example, in funds for target retirement year 2025, the investment mix may range from 60/40 stocks/bonds to a larger or lesser percentage of stock exposure. It all depends on the judgment of the money management firm sponsoring the fund.
Surz notes the federal Thrift Savings Plan uses target date funds with no more than 30% in risky assets at retirement, compared to the 401(k) plan offerings of major mutual fund companies with higher stock exposure.

Another concern: Most target date funds are designed to get you to retirement — but not through it. That fixed allocation percentage at your retirement date will stay the same for the rest of your life.

We will only know in hindsight which fund’s model was better. But the real concern is that with a high exposure to stocks, a bear market early in someone’s retirement could wipe out enough assets to impact their ability to withdraw enough money over their remaining lifetime.

On the other hand, over the long run, stock market exposure will protect against the ravages of inflation. And bonds can be risky, too, if inflation causes higher interest rates and lower bond prices.

A Target Date Alternative
Michael Falk, a CFA and expert on retirement planning, is another target date fund critic, calling them “a marketing solution masquerading as an investment solution.” He says the funds only add fees and complexity to the planning process — dismissing them only as “better than nothing.”

Falk points out that target date funds operate on the principle that “one size fits many.” But for individuals approaching retirement there is a wide variation: whether they will retire early, on time, or late; the life expectancy of each retiree; and the risk tolerance and self-discipline of each individual.

He suggests you could do better than a target date fund by creating a 50/50 portfolio using low-cost index funds — and rebalancing regularly. Or, he notes, you could simply buy a low-cost fund that does that for you — such as the Vanguard Balanced Index fund.

And Falk also worries about the relative riskiness of bonds these days, locking in low interest rates for the long term. An alternative plan, he suggests, is dividing your assets 75% in conservative, dividend-paying stocks and 25% in low-yielding cash. That strategy avoids the risks of bonds entirely.

No one knows for sure what the stock market will do in any given year. But this is your money, not investment theory. So, the one thing you should do immediately is examine the allocation in your target date fund and decide if it makes you uncomfortable. Perhaps move some to a low-yielding but no-risk money market fund.

You’ll sleep better at night, which is important in retirement. And that’s the Savage Truth.