Key Takeaways
- When an investor is getting close to a particular target date, usually their retirement date, target-date funds automatically change their asset allocation.
- Target-date funds can either see you “through retirement” or “to retirement.”
- Your goals, risk tolerance, and target date are some of the factors that influence whether target-date funds are a good investment.
The answer to the question of how you should save for retirement constantly changes, and it can be difficult for most people to choose the best investments for their retirement portfolio. This has contributed to the rise in the popularity of target-date funds. Over $1 trillion has been invested in target-date mutual funds recently.
Target-date funds have an understandable appeal. They follow the conventional wisdom that recommends that investors build wealth early in their careers by taking risks and reducing the level of risk in their portfolios as they get closer to retirement. Investors in target-date funds don’t worry about managing their investments. They invest their money and come back once it is time to retire.
What Is a Target-Date Fund?
A target-date fund is a type of investment that automatically modifies its asset allocation based on when an investor plans to retire. The idea behind target-date funds is to make investing easier for the average investor. You don’t need to choose particular funds or create a particular asset allocation model within your retirement plan because the target-date fund takes care of this for you.
How Do Target-Date Funds Work?
In a target-date fund, the asset allocation is determined by your expected retirement date. The fund’s risk level decreases as you get closer to retirement. In the early stages, funds typically hold more stocks or equity funds than less risky fixed-income investments like bonds. Over time, the asset allocation will start to move along “the glide path” and into a position that is less risky and is controlled by fixed-income instruments.
“To” or “Through” the Target Date
Your retirement may be supported “to” or “through” the given date by utilizing a target-date fund. A “to retirement” target-date fund will usually manage the specified asset allocation on the target date. Afterward, the fund’s allocation will generally stay the same through your retirement. A target-date fund that is meant to help you make it “through retirement” will usually reach the asset allocation after the date has passed.
Some target-date funds integrate into new funds that concentrate on building revenue once they reach their target dates. If your target-date fund integrates with another fund, assess the specifics of the new fund to determine whether it matches your investment objectives and the level of risk you are willing to take. In either situation, meeting the target date is not an indication that you have enough savings to reach your goal. How much you have invested, how well the fund is performing, and if you have other retirement income options on the table will all play a role in whether or not your savings goals will be met.
Are Target-Date Funds a Good Investment?
Target-date funds are not going to be right for everyone because they factor in your retirement date. If you could build a portfolio based on your unique needs, you could potentially see better returns, but this will require you to utilize all of your resources, requiring more time and money. This is part of the reason why target-date funds appeal to so many people. You can set it aside and forget about it. As with any mutual fund, you will need to consider any fees that you may accrue over the years. There can also be tax obligations if you own target-date funds and tax-advantaged accounts.
How To Choose a Target-Date Fund
- Choose your target date wisely.
- Determine the level of risk you are willing to take on.
- Know if the target-date fund will take you “to” or “through” retirement.
- Keep an eye on your target-date fund’s glide path.
- Find out if your employer has automatically enrolled you in a target-date fund.
Do You Know What’s Right For You?
Target-date funds are not all the same. Some are more expensive than others, but they can be affordable and they are tax-efficient. They also don’t require you to put forth much effort beyond the automatic monthly, quarterly, or yearly payment. You won’t have to worry about being an active investor and putting in the time and effort to monitor and rebalance your portfolio because target-date funds will handle that for you.
While convenience can be the way to go for some investors, others prefer having the freedom to customize their investment portfolio. So, how do you know which option is in your best interest? Getting advice from a financial professional can help you make the best decision based on your situation. At Roberts Tax and Retirement Planning, we would love to talk to you about how utilizing target-date funds in your retirement accounts can impact you now and in the future. Contact us today to book an appointment.
