A target-date fund is an exchange-traded fund (ETF) or mutual fund designed to optimize the growth of investments within a certain period. It operates a long-term vision to provide for the investors’ capital needs in the future. In practice, investors use target-date funds to grow assets in preparation for retirement.
However, in recent years, investors have repeatedly turned to these funds as a means to prepare for big future expenditures. The reason for this is that target-date funds are structured to periodically weigh the risks and benefits attached to certain assets within a certain duration of time.
How Do Target-Date Funds Work?
These funds make use of the established portfolio management system in targeting asset allocation to achieve the investment return objectives. They are long-term investments that grow assets till the investor decides to make use of them. Target-date funds are sought by many because it offers a long-term managed strategy for investment.
Also, target-date funds are named by the year the target-date fund matures, for example, the Target Retirement 2065 Products which was launched by Vanguard in July 2017. Target Retirement 2065 Products have a utilization target date of 2065 which puts the overall term of the fund at about 48 years.
Managers of this fund’s portfolio use the time frame of the fund to try to create a good strategy of investment based on conventional asset allocation standards. The fund managers use the target date to determine the degree of risk the fund is ready to take on. Target-date portfolio fund managers review and readjust the risk levels yearly.
Younger investors can undertake more risks with investments. However, as an investor inches closer towards retirement the fund will react conservatively, moving towards lower-risk investments. Over the term of the fund, as an investor draws closer to the target date, the portfolio manager will readjust the fund to have fewer equities and increased fixed income.
There are no guarantees for the fund’s principal value even at the target date. For this reason, it would be in your interest to monitor your investments either through your employers which are quite common practice in many offices or you could do it yourself.
Why Are Target-Date Funds Important?
Target date funds are a relatively low-risk investment. They have a diverse combination of fixed incomes and equities that are revised over time. This takes out the guesswork when making investments in preparation for retirement. Target-date funds are the preferred option for people who are planning for retirement to optimize their future retirement income.
If you have a 401k plan then it is likely that you are already invested in a target-date fund. Many plans use these funds as their main investment. It was discovered that as of 2020, not less than 50% of 401k investors have their entire 401k assets in a target-date fund.
In most target-date funds, the portfolio managers use a tool called the “glidepath” to determine the best investments for your target-date fund. The glidepath is a roadmap that guides your target-date fund investments. This tool is used also to measure the investment risks you would be exposed to over the term of your fund.
Do Target-Date Funds Have High Fees?
The average target-date funds have quite high fees as well as a high expense ratio of about 0.51%. This does not seem like a lot at first, but when compounded you’ll see a lot of lost investment returns over the term of the fund. So, if you have hundreds of thousands of dollars in the market for over 20-to-40 years then you could pay over $100,000 by the time you retire.
Are Target-Date Funds a Good Investment?
Target-date funds are a good investment choice which is quite simple even for persons who want to invest for retirement but lack the knowledge and skills to do so. Most 401k plans offer just one target-date fund with varying alternatives for the exact target date. This implies that you don’t need any other investments in your retirement portfolio.
Also, changes are made to the asset allocation automatically by the target-date fund’s portfolio managers. This saves you the hassle of manually reviewing and readjusting the asset allocation of your fund.
Despite all these positives, target-date funds have one main disadvantage. The fund uses the same asset allocation for everyone regardless of your goals and risk tolerance. For instance, if you dream of early retirement, you would be inclined to buy more stocks than most target-date funds would suggest.
Can You Take Money Out of a Target-Date Fund?
Yeah, there are two end requirements options open to an investor when the funds reach their target date. It’s either the investor withdraws a lump sum or gets an income-producing portfolio. Often, a target-date fund doesn’t stop investing once the target date is reached, it could go on with the process of moving from stocks to bonds.
Are Target-Date Funds Good for 401k?
One of the positive things about utilizing a target-date fund for 401k is that it offers a lot of diversification. That’s a bonus for employees starting a new job. Being a new employee who just started working a job also means having a relatively smaller account in most cases. Under such circumstances, it is best if you use a target-date fund for your 401k plan.
On the other hand, there are times when a target-date fund is not a good option for your 401k plan. If you have a big 401k from the savings you’ve made over ten years or more then you ought to consider upgrading your asset allocation to something that is customized to fit your needs and aspirations. Maybe you want a more diverse portfolio that goes into other asset classes such as global bonds, small equity, and real estate.
Key Facts About Target-Date Funds
Here are a few key facts about target-date funds.
1. Does Guarantee No Losses
Investors in target-date funds often misinterpret the diversification of their asset allocation to mean that their investment is safe. This is not true as there is always a level of risk and reward that comes with any investment. Also, if there is a drop in the value of investments, it could reduce the value of your target-date fund as well.
2. Conservative Investments
TDFs are often a mix of equities and fixed incomes as well as stocks and bonds. The investments are designed to be more conservative as the target date draws closer; this means that the asset allocation is moved to low-risk investments for investors nearing retirement.
3. Asset Allocation
Asset allocation is an investment strategy designed to weigh risk and reward by planning a portfolio’s assets according to the investor’s personal goals, risk tolerance, and investment knowledge.
How to Choose a Target-Date Fund
Some tips to keep in mind while choosing a target-date fund are as follows:
Pick a Target Date
Investors often pick a target-date fund whose name is closest to the time they want to retire. When picking a target date, choose a date that will best suit your retirement investment strategy.
Determine Your Risk Level
When considering funds and their target dates, pay close attention to their investment strategy so you can find a fund that is in alignment with your risk tolerance. Things could change over the term of the fund, so monitor the fund’s performance over periods to make sure it meets your investment goals.
Automatic Enrollment
Take out time to understand any target-date funds your employer automatically enrolls you for. Find out the fund’s defined retirement contribution plan. Depending on the situation, you can find a different option that is better suited to your retirement needs.
Look Out for Fees and Expenses
Compare various target-date funds and their fees and expenses by utilization of Financial Industry Regulatory Authority’s Fund Analyzer. Know that the fees and expense ratios make a great difference in the long run.
Examples of Target-Date Funds
Below are a few examples of prominent target-date funds.
Fidelity Freedom 2045
Fidelity Freedom 2045 looks to make high returns before the fund’s target date. The fund has an assortment of Fidelity domestic equity funds, international equity funds, bond funds, and short-term funds. This fund has an above-average fee and an expense ratio of 0.75%. There is also a considerable amount of risk that comes with investing in this target-date fund.
Vanguard Target Retirement 2045
Vanguard Target Retirement 2045 is a particularly popular target-date fund that provides general solutions about retirement account strategy. The fund assets are up to almost $33.81 billion that is invested in five different holdings as of March 2021.
American Funds 2060
This fund is designed to cater to investors that plan to retire in 2060. The American Funds 2020 is about achieving growth, income, and conservation of capital which is dependent on the proximity of the target date. The fund has a total expense ratio of 0.38%.
T.Rowe Price Retirement 2060
The T.Rowe Price Retirement 2060 seeks to give consistent returns by emphasizing capital growth and income. The fund seeks to achieve this through investing in T.Rowe Price stock, bond, and mutual funds in a well-diversified portfolio. It has a net expense ratio of 0.36%.
Target Date Funds vs Index Funds
Target-date funds differ from index funds in certain ways. A target-date fund is a fund that is made up of other funds because it collects monies from investors which are put in various mutual funds to get the best asset allocation. On the other hand, an index fund pools capital from investors and invests in one particular securities index to get a measure of that index.
One other difference lies in the way both funds are managed. Index funds are a passive investment as the managers only change to keep up with the benchmark as they track the index closely. Conversely, target-date funds are designed to minimize risk by readjusting asset allocation over time.
Bottom line
Target date funds are on average, more expensive and provide fewer returns compared with taking charge and managing your portfolio of passive index funds. However, if you do not have the knowledge or expertise required to manage your portfolio then maybe you’re better off investing in a target-date fund.
Whatever your choice is, ensure you consult a financial advisor whose expertise would aid you in formulating a proper plan for asset allocation.