By: Edward Chang
When facing two tasks, one important and urgent and the other unimportant and not urgent, we know which task to tackle first. Not completing the urgent, important task immediately may lead to a crisis, while the ill effects of not doing the other are negligible. However, when one task is important but not urgent and the other is unimportant but urgent, which will you choose to do first? If you are like most people, you will choose the unimportant but urgent task. In his bestselling book “The 7 Habits of Highly Effective People,” author Stephen R. Covey finds that if we neglect what is urgent but not important and attend to what is important but not urgent, we can escape a chronic state of crisis and do more creative work.
Saving for retirement is an important but not urgent task. We know we should start saving and investing early, perhaps beginning when our first full-time paycheck arrives. Unfortunately, however, few of us actually begin saving for retirement this soon.
One reason saving for retirement is delayed is that the process requires making important decisions such as determining the amount to be saved and invested and the type of investment. Regarding the latter, what are your best options?
Many investors have found target date funds of great use in making this decision. TDFs are designed to help investors revise their asset allocation as they move toward a pre-determined retirement date. Also known as “age-based funds” and “life-cycle funds,” fund managers of these investment vehicles adjust asset mixes to become more conservative as their clients reach retirement age. Investors are not required to select a fund consistent with the time they anticipate reaching full retirement age. They may choose a later TDF category if they prefer a higher risk/return al
TDFs are rapidly becoming a common means to prepare for retirement. As of March 2016, 518 TDFs have been in existence for over 10 years, providing a good sample period by which to assess their performance. Analysis of TDF return data, by my co-authors (Thomas Krueger and Mark Wrolstad) and myself, reveals that a significant factor in differentiating between TDF investment performance is their costs, including both expenses and loads. Lower expenses, especially selecting among TDFs with the lowest 25 percent of expenses in their respective category, have a significantly positive effect on return without an appreciable impact on risk. Selecting no-load TDFs increases return, risk, and risk-adjusted return. Evidence shows that common-sense practices like avoiding high expenses and loads will lead investors to better-performing TDFs.
According to Money magazine, new research shows millennials save earlier and more of every paycheck in a 401(k) plan than older generations. Because they were at an impressionable age during the recent financial crisis, many took its lessons to heart. Most enrolled in a 401(k) plan got there through auto-enrollment and many simply stick with their default option — a target-date fund. TDFs do provide solid diversification, but not all perform equally well. A solid start is to make certain you are contributing enough to get the full employer match and to choosing a TDF with a low expense ratio and no load Employers can also help their employees by picking one of these TDFs as the default choice.
C. Edward Chang, Ph.D. is a professor of finance at Missouri State University. His areas of specialization include performance measurement of investment vehicles and financial education.
This article appeared in the April 8, 2017 edition of the News-Leader and can be accessed online here.