Target-date funds are a system of making retirement investing easy and simple. They offer a single, ready-made portfolio for a future saving goal, such as funding a child’s education or saving for retirement. Target-date funds offer an all-in-one option that helps people stay invested and on track to meet their financial goals.
When you choose a fund tied to the year that you hope to retire, the investment mix shifts over time to balance risk and growth. Target-date funds are popular options for saving and investing for retirement. According to a recent report by the Investment Company Institute, over 30% of 401(k) assets are now invested in target-date funds, highlighting their growing popularity. However, it is not necessarily the best option for everyone.
Let’s explore what target-date funds are and how they work.
What Is A Target-date Fund?
Target-date Funds, or TDFs, invest in a diversified array of securities, including bonds, stocks, and other investments. They are most commonly used for retirement savings, where investors select a target-date fund based on their target retirement date. So, for example, if you are 25 years old now and plan to retire at age 65, you may choose a target-date 2070 fund.
Basically, target-date funds are structured to invest across many asset classes and securities, adjusting the mix of those classes to grow savings. The longer the investor’s time horizon, the greater their chances of achieving strong long-term growth. This is why target-date funds with target dates decades in the future tend to hold most of their assets in stocks.
If you already have a 401(k), then you would have a target-date fund strategy in place already that is managed with a retirement date in mind. 401(k) plans usually use them as their default investment. Likewise, target-date-based strategies are held in 529 college savings plans, where the target date is usually the year when the investor anticipates a child will begin higher education.
According to financial advisor Sarah Lee, “Target-date funds are a great way for many investors to stay disciplined over the long term, particularly for those without the time or expertise to manage their own investment mix.”
Different Types of Target-Date Funds
While target-date funds follow a similar path, various funds can be used for different investment strategies. They also come in various management styles. For example, some funds track benchmark indexes, others are actively managed, and some use a combination of both approaches. The differences between them can affect the fund’s costs, risks, and allocations.
The three investment approaches implemented by target-date funds are listed below:
Active
Usually, an active portfolio management team will select actively managed investments in order to outperform broad market indexes.
Passive
Passive investments will be selected with the objective of achieving performance aligned with an index.
Hybrid
A hybrid portfolio management team will use a mix of the above options, depending on where and how it believes they will add more value.
Benefits of Target-Date Funds
What makes target-based funds stand out is their simplicity: select a date and start investing in a diversified portfolio. Here are some of the pros of target-based funds:
- Longevity risk is the risk of outliving your money. When you invest for growth potential, your investments help keep up with inflation and grow beyond it. Most target-based funds tend to maintain a solid level of stocks up to the goal date, so your money can continue to grow.
- A common risk of investing is that your investment can lose value due to market fluctuations. Of course, completely removing market risk is impossible, but target-based funds can help manage it by holding a broader range of investments. This diversification ensures that periods of market volatility can be managed more effectively because even if one investment falls, another can cushion the impact.
- Historically, stocks have outpaced inflation over long periods, so allocating to target-date funds helps manage inflation risk.
- Target-based funds are designed to support long-term discipline by offering a single age-based solution. This allows investors to remain invested throughout market cycles and reduces the temptation to adjust their investments in response to short-term market movements.
Disadvantages Of Target-based Funds
Target-date funds are certainly popular as they’re often perceived as an “easy” option. But this doesn’t necessarily mean that it’s ideal for everyone.
For example, target-based funds can be more expensive than other investment options. This is because you have to pay not just for the target-date fund itself but also for the various funds it invests in. Moreover, target-date funds are designed as a “one-size-fits-all” model, but the truth is that each person’s financial goals and risk tolerance can vary widely. So there is really no guarantee that it will align with your situation.
With target-date funds, asset allocation is managed automatically, and investors don’t have complete control over the portfolio decisions. So people who would like the freedom to adjust risk levels or curate their investments may find this restrictive.
Emily Chen, investment strategist, warns, “While target-date funds are convenient, investors should remember that the ‘one-size-fits-all’ approach may not suit everyone’s unique goals.”
Should You Invest In A Target-Date Fund?
Well, the answer to this will depend heavily on your personal investment style. If you would like a hands-off approach and find that your risk tolerance aligns well with others your age, then it can be a suitable option. Likewise, it’s a great choice if you have a known savings goal or target retirement date but don’t have the skills or time to build a diversified portfolio.
On the flip side, if you want to choose your investments and be more actively involved, a target-date fund may not be ideal for you. As with any investment, you need to carefully weigh your options before deciding to invest in a target-date fund. One important consideration is the fee, but also factor in your goals and the pathway for any prospective funds.
If you have a simpler financial life and plan to retire at a standard age, the uncomplicated, one-size-fits-all approach of target-date funds can be beneficial. But if you want a more curated approach, it would be better to discuss this with a financial advisor to help you map out a financial plan aligned with your goals.
