Setting a target
Target date funds are solid choices for those who invest to make sure they can live comfortably once they retire. These funds are structured so that the asset allocation gradually shifts over time to one that These funds go from including holdings that are based on a growth-oriented approach, to holdings that are low-risk and conservative.
The idea of target date funds caters to the general ideal that one should be more aggressive in their investment choices while they are young. Then, as they get older, they should become more conservative, and take on less risks, in their choices.
Time is of the essence
When choosing to invest in target date funds, it’s important to understand your time horizon. This simply refers to the amount of time you expect to hold a particular stock, or other security.
As noted by Investopedia, the investment horizon determines the investor’s income needs and desired risk exposure, which aid in security selection. Often, those who begin investing when they are young can deal with market declines because their time horizons are long enough to provide sufficient time for their holdings to rebound if they dip.
On that same note, those who are middle aged may find their time horizons are not long enough to sustain a decline so that any losses can be recouped before they retire.
Target date funds address these issues because initially they can be stocked with securities that carry more risks, but have the potential to reap better returns. They can then be gradually altered to include less risky investments as the retirement date nears. These funds automatically adjust their asset mixes to become more conservative as that much-anticipated retirement date approaches.
Pros and cons of Target Date Funds
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| PROS | CONS |
|---|---|
| Low maintenance | No index to compare |
| Automatic risk adjustment over time | Generic – not meant for individual needs |
| Good for inexperienced investors | Some have excessive fees |
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Who’s best suited for target date funds?
CNBC says about these funds that they are “tailor-made for those who prefer to put their investment portfolios on autopilot.” They tend to appeal to those who have 401 (k) plans.
The increasing popularity of the funds has led to forecasts that they will represent nearly half of the projected $7.7 trillion in U.S. defined contribution assets by 2020, according to CNBC.
All are not enamored with the funds, especially for those who are younger than 45 years old.
In an interview with the media outlet, financial analyst Jon Stein said:
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“If you want more control of your investment choice, you may consider a mix of low-cost, long-term equity funds, or index funds, and low-cost bond funds, rebalancing every five years to reflect their changing risk tolerance and time horizon.”
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These funds invest in other funds that cover many asset categories. These include stocks, bonds, and alternative investments. It’s also important to note that the funds can be actively, or passively managed.
Gliding into riches
A top question is how quickly, and when do, these funds shift their holdings. This shift is referred to as the glide path.
Investopedia explains how target date funds are structured:
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“To” funds structure their glide rate to achieve the most conservative allocation right at the target date, while “through” funds will not reach their most conservative allocation until after the target date in order to provide a hedge against inflation.”
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It is thought by many financial advisors that “through” plans are typically more aggressive than “to” plans because they tend to maintain a larger stake in equities long after the target retirement date is reached.
Many employers include target date funds through their retirement savings offerings, but you likely won’t be able to control what’s included to achieve your ideal glide path. Don’t fret, however, as you can build your own portfolio, but that’s going to require you to do more work on your own.
By taking on the responsibility, you can build your portfolio to reflect the glide path that’s best in line with your needs. Also, you shave off the fees that come along with having a broker structure your portfolio.
