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Target-date funds are retirement accounts that choose investments for you based on your expected retirement age. As you get closer to retirement, target-date funds will automatically shift your asset allocation away from high-risk securities toward a more conservative asset mix. Target-date funds rebalance themselves, allowing the investor to take a more hands-off approach to retirement saving.
Here's how target-date funds work so you can decide if this investment option is right for you.
How Do Target-Date Funds Work?
Target-date funds are age-based investments built around when you want to retire. Most are structured as actively managed mutual funds, where a fund manager makes investment choices on your behalf in the hope of outperforming average market returns. Instead of investing in individual securities, target-date funds often invest in other mutual funds and exchange-traded funds (ETFs).
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A healthy investment portfolio typically includes a mix of low- and high-risk investments. Riskier assets like stocks are often needed to net larger returns and fuel growth. Meanwhile, safer investments like bonds can provide reliable income and stability. Target-date funds aim to capture the best of both worlds based on your age and how many years you have left until retirement.
If you're a long way out from retirement, target-date funds will invest more of your money in equities and other high-risk, high-return investments. As you age, the funds will lean heavier into safer assets, cutting your exposure to equities as you get closer to retirement. Exiting the workforce with a stock-heavy investment portfolio can be risky. If the market dips, it could significantly deplete your nest egg. A well-balanced portfolio is meant to mitigate that risk.
Pros of Target-Date Funds
Target-date funds offer several advantages for investors:
A major selling point of a target-date fund is its simplicity. It rebalances your fund assets for you using the parameters you set based on when you want to retire. And since most target-date funds are actively managed, the fund manager handles the investment choices and specifics around your asset allocation. The investor simply has to make contributions.
Peace of Mind
Investing of any kind comes with risk, but target-date funds reduce your exposure to high-risk assets as you age. During your younger years, target-date funds typically take a more aggressive approach. This can set the stage for real growth over time, especially in the face of inflation. All the while, the fund itself is designed with diversification in mind.
Investments Beyond Retirement
While some target-date funds reach their most conservative asset allocation when you reach your expected retirement year, others will continue rebalancing years into retirement. (These are called "through" target-date funds because they take you through retirement.) This structure can be appealing to retirees who want to continue investing in equities after they exit the workforce.
Cons of Target-Date Funds
While target-date funds offer convenience and simplicity to the investor, there are drawbacks to consider:
Most actively managed mutual funds charge fees to cover operational costs, which includes compensating the fund manager. The average expense ratio is 0.74%, which translates to $74 for every $1,000 invested. There might also be a minimum initial investment to buy into a mutual fund. This can range anywhere from $500 to $3,000.
Not Totally Hands-Off
While target-date funds don't generally require much from investors—the fund itself does most of the heavy lifting—it's still wise to periodically check in on the fund. Some questions to ask yourself include:
- How is your target-date fund performing? Are you satisfied with its investment strategies and returns?
- The rate at which a target-date fund shifts toward safer investments is known as its glide path. Is your fund's glide path and asset allocation still compatible with your risk tolerance and goals? You may find that it's too conservative or risky based on your needs.
- How does your target-date fund mesh with your greater investment portfolio? Depending on your retirement timeline and goals, you may need to further diversify your investments elsewhere.
Are Target-Date Funds a Good Investment?
Whether a target-date fund is a good choice for you depends on your investing style, goals and risk tolerance. Target-date funds might make a lot of sense for an investor who prefers a set-it-and-forget-it approach to retirement saving. Just remember that this type of account alone likely won't meet all your retirement income needs. Other investment accounts, like a traditional IRA, Roth IRA, 401(k) or regular brokerage account, can help round out your nest egg.
Investors who prefer to play a more active role might find target-date funds restrictive—your investment choices and asset allocation will be out of your hands. This can be a blessing or a curse, depending on how you prefer to invest.
How to Invest in a Target-Date Fund
Target-date funds are common among employer-sponsored retirement plans. If you're already contributing to a 401(k), check with your plan administrator to see if it includes a target-date fund and, if so, what the glide path looks like. The same can be said if you have an IRA.
Alternatively, you could open a target-date fund yourself through a brokerage. It pays to do some comparison shopping here. Be sure to consider the following details before making a decision:
- How do the fees measure up?
- Is there a minimum opening investment?
- How is the glide path structured?
- Is the asset allocation compatible with your risk tolerance?
- When does the fund reach its final asset allocation (upon retirement or after)?
The Bottom Line
Target-date funds are one way to pad your nest egg ahead of retirement. They're ideal for investors who are looking for a simple, streamlined approach. You won't have a say in your investment choices and asset allocation, but that could be good for investors who are prone to being reactive in the face of market volatility.
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