A target date fund is an attractive option for savvy passive investors. These mutual funds provide strong results with minimal effort, and adjust your investment risk level according to how soon you plan to retire. As a result, many 401k and IRA investors choose them as the backbone of their personal investment portfolios. As with any investment, however, not fully understanding these financial resources can cost you plenty.
In 2008 and 2009, many target date fund investors lost fortunes learning that funds without well-designed “glide paths” can leave you dangerously overexposed to stocks in the few years right before expected retirement. If you know how target date funds are designed – as well as their benefits and downsides – you’ll be able to choose the best target date fund for your portfolio.
What Is a Target Date Fund?
Simply put, a target date fund is a mutual fund that lets you select a particular year as the goal for maturity of the fund. A 2050 target date fund, for example, expects that you’ll retire in 2050, and fund managers adjust the portfolio’s asset allocation accordingly. In theory, the fund will be heavily invested in stocks during the early accumulation phase, and it will shift toward cash and bonds in later years as the target date gets closer. Most target date funds finish up with a portfolio made up almost exclusively of fixed income securities like bonds, treasuries bills, and cash, with a small amount remaining allocated to stocks for further growth.
Why Choose a Target Date Fund?
- They’re enticingly low maintenance. The “hands-off” nature of these investments allows you to be confident in your allocation without submitting yourself to the everyday hazards of the stock market.
- You’ll have a diverse portfolio almost instantly. Target date funds invest internationally and across many segments of the economy. They also offer diversification in asset classes, so you’re not subject to a change in just one type of investment, one market sector, or one nation’s success.
- You’ll get the best timing for taking a risk on stocks. You probably didn’t invest in stocks much when you were starting out, because they’re too risky, especially for a novice. But the early years of retirement planning are often the best time to take chance, and a target date fund helps avoid underexposure to stocks early in your investing career.
Things to Beware Of
- Check the “glide path,“ which is Wall Street’s term for the way the fund will scale back on risk in the later years of the fund. You’re ideally looking for a smooth path that adjusts annually, not one with drastic changes that only happen every ten years. A target date fund means you don’t have to monitor your portfolio frequently, but you don’t want to pick a fund that will have you waiting anxiously for an adjustment when the economy takes a bad turn.
- Watch out for the expenses and fees that always come along with mutual funds – and almost any investment. The most successful long-term investors realize that over time, high expenses take a big cut out of a portfolio’s gains. Look for no-load funds and check the prospectus to make sure that the target date fund you choose doesn’t pay the underlying funds an additional investment management fee. Ideally, seek a target date fund with expenses below 1%.
Hopefully, you take the opportunity to contribute to your 401k or IRA and save for retirement at a young age. But especially when you’re first starting out, it’s easy to be baffled by the paperwork, especially if it’s just one more part of your benefits package at work. Not only do you end up making mistakes by rushing through your selections, you often have to make difficult decisions in your twenties and thirties, not knowing what effect they’ll have on your retirement at all.
A target date fund takes the pressure off. Once you figure out how many years are left until your desired retirement age, it does the math and takes the risks for you. There’s no shame in being a “hands-off” investor, especially when you’re first learning about the market. Armed with the right cautions, like checking the glide paths and fees, you’ll be comfortable trusting the pros. A target date fund lets you take risks at the right time, parking your savings in a strategic account that you can watch grow.
Have you already chosen a target date fund? Share your success stories, or let us know if you took a tumble on a bad glide path.
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