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What Are Target Date Funds?

What Are Target Date Funds?

December 29, 2020

Target Date Funds: Is that when you save money to take out someone special? 

 

The so-called “accumulation” phase of your life is the one where you’re working and putting money aside for retirement, usually in a 401(k) or an IRA. The saving part is fairly easy – you set up a percentage that automatically comes out of your paycheck.  But it gets complicated when it comes time to invest the money.  That’s where Target Date Funds come in.  

Target Date Fund Basics

Target date funds (TDFs) follow a strategy that identifies a point in the future – usually close to the year of retirement – and then builds an asset allocation around a risk tolerance that changes as you get closer to the target date. The benefit to the investor is that you don’t have to monitor and update your asset allocation yourself. The benefit to the plan is that these types of funds help them meet ERISA (the law governing employer-sponsored retirement plans) requirements. That’s one reason why so many funds offer them. 

The funds include both stock and bond investments. It’s the percentage mix of these that determines the risk tolerance. Here are some hypothetical examples of possible asset mixes: 

2065 Fund: 90% in stocks; 10% in bonds

2040 Fund: 85% in stocks; 15% in bonds 

2020 Fund: 55% in stocks; 45% in bonds

As you can see, the closer you are to the target date, the more conservative the asset allocation becomes, as the equity portion decreases and the bond portion increases. This change in the asset allocation over time is called the “glide path.”

Are TDFs A Good Idea? 

Well, it’s tricky. On the one hand, investors like them because they perceive a benefit of simplicity: They seem easy to invest in and no ongoing portfolio maintenance is needed. The reality is somewhat different. All target date funds are not the same; even funds that target the same year can have very different makeups. You still need to do the same amount of research on a target date fund – all the way through to the underlying investments – that you would have to do if you picked individual funds and created an asset allocation yourself. 

And the target date fund of course can’t respond to anything going on in your life – if things change for you, such as you decide to leave the workforce or you take a cut in pay or even get a big increase in pay – the fund just keeps chugging along. If you want to change your asset allocation, you’d need to sell out of the target date fund and buy new funds to replace it. 

What About Holding Them After Retirement? 

Keeping an investment in a target date fund after you’ve retired may not be the best possible investment strategy for you. Depending on what your retired life will look like, you may not want to keep decreasing risk over time, if you have high income needs and want a portfolio that can still grow. Transitioning into retirement isn’t like any other period in your investing life.  It makes sense to take a fresh look at your investment strategy and be sure it pairs with how you want to live in retirement and what you want to accomplish.

The Bottom Line  

Target date funds are certainly popular, but the benefits shouldn’t be misunderstood: They require the same investment research that any other investment would, and you should be continually tracking them to make sure they meet your goals. And when retirement hits – it’s a good idea to rethink your complete investment plan to correspond with this new phase of your life.