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Default funds and retirement plans: Avoiding guesswork

Kelly Kowalski, Cliff Noreen, and Bronwyn Shinnick

Posted on June 17, 2024

By:  MassMutual Staff

Our executives and experts team up to write educational articles, covering a variety of financial topics such as life planning, college savings, and retirement.
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Note that most workplace retirement programs have default funds for those employees who don’t select specific investments.

Explain how risk-based funds are geared toward different tolerances for risk.

Describe how target-date funds work for retirement purposes.
 
   

Choosing how to invest your workplace retirement plan savings can be a daunting task. All this jargon like “risk,” “equities,” “asset classes,” and “diversification” can be overwhelming. So, what happens if you don’t feel comfortable choosing investments? If you don’t select any investments for your retirement savings, your employer will choose for you. Each retirement plan has a “default” investment option for participants who do not choose investments. You also can choose the plan’s default fund or move your existing money into the default fund, which may make sense for some investors.

Popular default funds, such as risk-based funds and target date funds, may help remove some of the guesswork typically associated with retirement plan investing. (Related: What is a 401(k)?)

These funds will automatically invest your savings across many different investment types in a mix that is appropriate for your risk tolerance or age group. For this reason, they are considered total portfolio solutions so that your retirement plan account should only invest in one of these funds and nothing else.

Common types of default funds

Employers typically choose one of the following types of investments as a default fund in their plan.

Risk-based funds are a group of funds that are managed to maintain a certain level of investment risk. Risk-based funds are often categorized as conservative, moderate, or aggressive.

  • A conservative fund would include a greater proportion of low risk (more stable) investments to prevent the potential for large losses in the fund, though the potential for high returns is reduced.
  • In contrast, an aggressive fund would include a greater proportion of high risk (more volatile) investments that carry a greater chance of loss but also a greater potential for higher returns.

Because risk-based funds are designed to align with a specific level of risk tolerance, they are rebalanced regularly to maintain a static investment mix.

Retirement plans that offer risk-based portfolios usually provide an online questionnaire or other tools to help you determine which fund is most aligned with your risk tolerance and retirement savings objectives. Based on your responses to the questions, you will be directed to a portfolio or a fund with a specific investment mix. (Related: Why identifying your risk profile is essential to investing)

Target date funds are a group that is managed to meet the accepted investment objectives of an investor based on their age or number of years until retirement.

For instance, if you are 35 in 2024, you will be 67 (i.e., full Social Security retirement age) in 2056. So, you might want to choose a Target Date 2055 Fund, if offered by your plan. Target date funds are created in 5 or 10-year increments, so you would choose the fund with the date closest to when you think you will retire.

The underlying investments in a target date fund are managed based on the time horizon until the target retirement year. The longer the time horizon, the more aggressive the target date fund can afford to be because there is more time to ride out any market downturn. On the other end of the spectrum, investors who are closer to retirement have less time to recover from a market decline, so target date funds with a coming retirement year typically maintain a more conservative investment mix.

Like risk-based funds, target date funds are a well-diversified investment. Target date funds, however, do not maintain a static investment mix. One of their advantages is that their investment mix automatically adjusts over time. As you get closer to your retirement year and your time horizon shortens, the investment mix becomes more conservative.

Check your investments

Whether your employer automatically selected the plan’s default fund or you chose the default investment, you can rest assured that it is a well-diversified investment portfolio that can be a prudent investment solution. (Related: Why a balanced asset allocation isn't one and done)

However, your retirement savings is a valuable financial asset, so it’s wise to revisit your investment selections periodically to ensure you’re still in the best option for you. Your financial professional can help you choose the investments best suited for you.

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Investing involves market risk. Neither target date nor risk-based funds guarantee gains or prevent investment loss.

Generally, target retirement date (lifecycle) investment options are designed to be held beyond the presumed retirement date to offer a continuing investment option for the investor in retirement. The year in the investment option name refers to the approximate year an investor in the option would plan to retire and likely would stop making new contributions to the investment option. However, investors may choose a date other than their presumed retirement date to be more conservative or aggressive depending on their own risk tolerance. Target retirement date (lifecycle) investment options are designed for participants who plan to withdraw the value of their accounts gradually after retirement. Each of these options follows its own asset allocation path (“glide path”) to progressively reduce its equity exposure and become more conservative over time. Options may not reach their most conservative allocation until after their target date. Others may reach their most conservative allocation in their target date year. Investors should consider their own personal risk tolerance, circumstances and financial situation. These options should not be selected solely on a single factor such as age or retirement date. Please consult the prospectus (if applicable) pertaining to the options to determine if their glide path is consistent with your long-term financial plan. Target retirement date investment options’ stated asset allocation may be subject to change. Investments in these options are not guaranteed and you may experience losses, including losses near, at, or after the target date. Additionally, there is no guarantee that the options will provide adequate income at and through retirement.

The information provided is not written or intended as specific tax or legal advice. MassMutual, its subsidiaries, employees and representatives are not authorized to give tax or legal advice. Individuals are encouraged to see advice from their own tax or legal counsel.