Target Date Funds
A Simple Investing Alternative
If financial freedom is your goal, but you don’t know how to invest, target date funds are a simple investing option that you may want to consider.
Though not for everyone, these types of funds may be good if you are looking for a “hands off” approach to investing.
A target date fund is a type of mutual fund which has a mix of investments that becomes more conservative as the target date approaches. The “target date” is usually the year that you are planning to retire.
While the focus of this article is target date retirement funds, a similar approach can be taken for a college saving plan as well.
Target Retirement Funds –
Changing Over the Years
A young person, who is many years from retirement, can usually afford to have an aggressive mix of investments that are comprised heavily of equities. This type of portfolio may deliver a high, yet volatile return.
On the other hand, someone who is close to retirement would want a more conservative mix. This type of portfolio would have a larger holding of bonds and less of equities, resulting in a safer, more stable return.
Sometimes it is difficult for an investor to maintain an appropriate allocation throughout the years. Target date retirement funds take care of this by gradually reallocating their portfolios from aggressive to conservative as the target date approaches.
This reallocation, over the life of the fund, is called the “glide path.”
Target retirement funds are offered by large mutual fund families and are available in many 401k retirement plans. They usually include the target year in the name of the fund. So, if you are planning to retire in 2035, you might choose a fund with “2035” in the name.
Before You Invest in Target Retirement Funds
Before you decide to put your savings in target retirement funds, here are some things to consider:
- Do you want to be actively involved in managing your own investments? If so, target date retirement funds are not for you. They are better for someone who wants to put their money away and then forget about it.
- Each fund is usually a ”one size fits all” type of investment. It doesn’t allow for the individual differences in risk tolerance, investment goals, or retirement needs.
- Because these funds aren’t suited to individual needs, they are often a less expensive alternative than using a personal financial advisor. However, the expenses can vary a great deal between funds, so understand the costs before you invest.
- It is important to understand how different funds approach the tradeoff between longevity risk (the possibility of outliving your savings) and investment risk (the possibility that your investments could decline in value).
To better minimize longevity risk, some funds take on more market risk in order to gain higher returns. Keep this risk versus return balance in mind when selecting a fund.
- A target date fund often invests in several mutual funds rather than investing in individual stocks and bonds. It is important to investigate the quality of the underlying investment in mutual funds.
- Do you want a ”target to” or “target through” fund? Some funds are designed to reach their ultimate mix of equities and bonds at retirement. Others follow a glide path to the ultimate mix sometime after retirement.
In deciding which is right for you, consider how much risk you are willing to take on in order to keep your investments growing after retirement.
An investment strategy is an important part of financial planning for retirement. If you aren’t interested in managing your own investments, you may want to consider target date funds.
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