Target-Date Investment Funds
During the past 20 years, target-date funds have become more popular with investors. Also known as life-cycle, retirement, or age-based funds, target-date funds were first introduced in the early 1990s. Mutual funds offered instant diversification by pooling money and investing in the major asset classes (stocks, bonds, alternative investments, cash). This gave small investors access to a diversified portfolio of stocks, bonds and other securities.
As I mentioned in a previous article, more than 90 percent of the gains from an investment portfolio come from your asset allocation, or how much of each asset class you have. If you are close to retirement, you normally would have more conservative investments in your portfolio, such as bonds and cash. If you are young, then you may have a larger allocation of stocks in your portfolio. People would invest in multiple mutual funds that represented the different asset classes to come up with their own asset allocation based on their personal goals, time horizon and risk tolerance.
Target-date funds took it one step further by not only offering instant diversification, but also instant asset allocation. Target-date funds are based on dates. They typically contain a mix of stocks, bonds and money-market funds that automatically adjust as you approach the date. For example, if you plan to retire in 2030, you would select a 2030 target-date fund. As you get closer to retirement, the fund automatically shifts to a more conservative allocation. Target-date funds use a “glide path” to adjust the risk levels over time in order to meet the goal of investors’ starting to withdraw the money that particular year.
There are several benefits of target-date funds. It makes it easier and more convenient for people to invest without having to worry about adjusting or setting their own diversification and asset allocation. Instead of choosing a number of investments and trying to figure out the right amount of each one, you can choose a single fund and remove the guesswork. The only thing you have to do is pick a date. The funds also automatically rebalance when appropriate.
Some of the drawbacks are that expenses of target-date funds are generally higher than a fund that invests directly in stocks and bonds. They also only are based on year, not on the preferences of the investor. Even though the retirement year may be the same, workers may have different goals and risk tolerances. For some investors, they can be generic and not personalized enough. Some funds are also “to” retirement while others are “through” retirement. There are currently more than 600 target-date funds, and although the retirement date may be the same, they each have their own fee structure and risk profile, and vary widely in their asset mix. It is difficult to compare them to one another or any one benchmark. You will have to do research to pick the right one.
While there are some downsides, target-date funds are a simple way for many people to invest for retirement without having to do it themselves.
Visit artofthinkingsmart.com to see my favorite target-date funds.