If you are a “set it and forget it” investor that simply wants a portion of paycheck automatically invested each month into your retirement account with no intentions of touching it until you retire, the concept of target date retirement funds has probably appealed to you. The funds take some of the difficulty out of investing as you choose a fund that matches your target retirement date (i.e. 2050), and your money will automatically shift to more conservative investments as you near retirement.
What Are Target Date Retirement Funds?
A target date retirement fund is an actively managed mutual fund that is managed by a fund manager and follows a fund strategy. When you are young the fund might invest 90% in stocks & 10% in bonds. This investment allocation has the highest growth potential, but, when a market downturn does occur, your portfolio value will also drop the most.
As you near retirement, the target date fund will gradually sell stocks and buy more bonds, a traditionally less volatile investment with a steady income. Assuming you invest in a 2050 target date fund because you plan to retire around that same year, the asset mix in 2045 might be 50% stocks and 50% bonds. You might not earn the same high yield as you did with more exposure to stocks, but, your portfolio is less likely to sharply drop in value and make you unable to afford retirement.
Pros about Target Date Funds
There are several advantages to investing in target date funds:
Great for people who have no clue how to invest
Many people choose not to invest because they do not understand how to invest. Instead, they only earn a small percentage of interest by keeping all their money in a bank account. Target date funds are great for people that don’t know the difference between a large cap & small cap fund. By picking a fund that matches your retirement date, you also have the added safeguard of knowing your investments are not too risky when you are old or too conservative when you are young.
Target date funds might not have the highest rate of return in the investment industry, but, they are usually better than just keeping your money in a bank account with 0.50% interest.
Cheaper than a traditional broker
Before the internet made online DIY investing possible, the only way to invest was through a broker that earns a small commission on each trade. Target date funds essentially have the same goal in mind as your traditional broker, managing your money for every stage of life, for a fraction of the cost.
Cons about Target Date Funds
And, there are a few dislikes regarding target date funds:
Target date funds are more expensive than index funds
Target date funds are great if you do not want to constantly check your profile and rebalance it, although you still should monitor its performance at least once a year. Target date funds are a great way to help people invest that know almost nothing about investing, but, because they are managed by a human they have higher expenses than index funds that simply try to match the market performance of a particular index like the S&P 500 or the Russell 2000. You might also decide to own a small index fund that matches the market for less cost.
No two target date funds are the same
Finally, there are a handful of choices for each retirement year. Still using 2050 as our example, the 2050 target date fund by American Funds holds approximately 85% in stocks while Vanguard’s fund has close to 90%. You might only have one option if you plan to invest in a target date fund through your employer 401k, but, by investing outside your employer 401k will give you the opportunity to choose a fund with a better historical performance or an ideal asset allocation.
Target date funds probably aren’t the best option for advanced or experienced traders that can handle trading several stocks at a time. For those that don’t like the research & time required to invest effectively or don’t even know where to begin investing will benefit the most from a target date fund.