Article
Target date retirement funds (also known as target date funds) are a popular option for managing your retirement savings. Often offered by retirement plan providers like 401(k) plans, these funds are designed to offer a simplified approach to long-term investing and retirement planning. Knowing how these funds work may help you to decide whether or not a target date fund will benefit your retirement.
How do target date funds work?
Target date funds are structured around a specific retirement year or “target date.” Investors should select a target date fund that aligns with their expected retirement year. Early on, the fund aims to maximize long-term growth potential by primarily investing in stocks. The specific allocations and investments within the fund are determined by the fund manager. Younger investors typically have a longer investment horizon and can tolerate more risk. As the retirement date approaches, the fund gradually becomes more conservative, increasing its allocation toward bonds and other fixed income investments. The goal of this gradual shift in allocation is to focus on capital preservation and risk management as the investor approaches retirement age and may need to start withdrawing funds.
Why choose to invest in target date funds?
Target date funds are simple, convenient, diverse, and cost efficient. The following offers more explanation of each:
- Simplicity and convenience: One of the primary advantages of target date funds is that they are designed to be straightforward and simple to use. Once you choose a fund based on your target retirement date, the fund manager handles all the asset allocation decisions and rebalancing (bringing your portfolio back in line with your target allocation). This kind of management can be particularly appealing if you lack the time, expertise, or desire to actively manage your investments.
- Diversification in a single fund: Target date funds are typically composed of a broadly diversified portfolio of investments, meaning the fund’s dollars are spread across different types of investments to help manage risk in your portfolio. Since holding multiple funds in your 401(k) may result in overlapping investments and differing objectives, owning a single fund provides the benefits of broad diversification while avoiding duplicate investments in your plan.
- Cost efficiency: Many target date funds offer competitive expense ratios, which can be lower than the fees associated with actively managed funds or having to build and manage your own diversified portfolio. Lower expenses can result in higher returns over the long term due to the power of compounding. Be sure to check with your plan provider to determine fund-specific fees.
Is a target date fund the right choice for me?
Target date funds can be a great choice for investors with straightforward goals and needs, or investors who lack the time or skill to construct a diversified portfolio. Consider your individual financial goals, risk tolerance, and investment time horizon when selecting a specific target date fund.
Not all target date funds are created equally, so it is important to review the details, fees, historical performance, and strategy of the specific fund before making an investment decision. Periodically review your investments to ensure they remain on track with your retirement objectives. As with any major investment decision, consider consulting with your financial advisor to ensure that your investment choices align with your long-term financial plan.
