Target Date Funds are a popular retirement savings option that helps investors avoid the hassle of making asset allocation and re-balancing decisions. Target date funds are a type of mutual fund offered by an investment company that seeks to grow assets over a specified period. The strategy of these funds addresses an investor’s capital needs at some future date—hence, the name “target date.” This date is most of the time around the year you are expecting to retire. I want to try to help you understand the details and if you should invest in Target Date Funds.
How does a Target Date Fund Work?
Target-date funds use a traditional portfolio management methodology to target asset allocation over the term of the fund to meet an investor’s specific retirement date objective. These funds are considered to be extremely long-term investments.
Fund portfolio managers use their predetermined time horizon to develop an investment strategy, which is generally based on traditional asset allocation models. The fund managers also use the target date to determine the degree of risk they are willing to undertake. Target-date funds typically adjust risk levels annually.
In the initial stages of a target-date fund’s life, it invests in high-risk assets, such as stocks. At annual intervals, the fund adjusts its holdings to become less risky over time. As a target-date fund approaches its target date, it becomes more conservative in its portfolio mix and risk level. The higher-risk portions of a target-date portfolio typically include domestic and global equities; the lower-risk portions include fixed income investments such as bonds and cash equivalents.
Why should you invest In a Target Date Fund?
In most cases for these funds the individual investments that it consists of will be the same, and only the amount allocated to each will change over time. The asset allocation change between two dates is usually quite small until you get to the 10 year increment from the target date which will have a more drastic change of allocation to bonds.
Target-date funds offer investors the convenience of putting their investing activities on autopilot in one vehicle, but that might not be great if the investors’ goals periodically change. In addition, some people include other investments alongside a target date fund, which eliminates its key positive which is to have a set balance asset allocation. I recommend if you choose to use a target-date fund in your 401k or retirement account you should have it as your complete choice.
What are Advantages of Target Date Funds?
Target-date funds are popular with 401(k) plan investors because of the convenience of having a single fund that can be targeted to their retirement horizon. For example, a younger worker hoping to retire in 2045 would choose a 2045 target-date fund, while an older worker hoping to retire in 2025 would choose a 2025 target-date fund.
Some financial professionals advise that if you invest in one, it should be the only investment in your plan. This “one-and-done” approach is because additional investments could skew your overall portfolio allocation. However, after you’ve picked a fund, you have a hands-off investment that requires little to no maintenance.
What are Disadvantages of Target Date Funds?
One drawback with target-date funds is that the predetermined shifting of the portfolio assets may not suit an individual’s changing goals and needs. People grow and change, and so do their needs.
If you retire early or decide to keep working beyond the funds target date, there is no guarantee that your fund will generate a certain amount of income or gains. Also, there are no guarantees that your fund’s earnings will keep up with inflation. In fact, there are no guarantees that your fund will generate any income or gains at all. A target-date fund is an investment, not an annuity. As with all investments, these funds are subject to risk and under performance.
Furthermore, target-date funds can be costly. They are technically a fund of funds that invests in other mutual funds or exchange-traded funds, which means investors pay the expense ratios of those underlying assets and fees of the target-date fund.
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