Like many investors, you may rely on mutual funds and investment professionals to put your money to work for you. And, investing in a mix of stocks and bonds within a single mutual fund can help keep your investments diversified.
The two most popular types of these all-in-one mutual funds are target date funds and target risk funds. Though their investment philosophies differ, both are designed to help you realize your investment goals in a more convenient way.
Target date funds
Target date funds offer a straightforward way to diversify your investments. You simply select a mutual fund based on the year you plan to retire, and the fund automatically adjusts over time to stay in line with your investment goals.
You don’t need to rebalance or select any underlying funds—the single target date fund does that for you. The mix of assets within your account gradually shifts from an aggressive to a more conservative risk profile as the target date approaches.
This single investment approach is appealing, but there are a few things to keep in mind, when saving for retirement.
- Variations in risk levels. Not all target date funds are created equal, even if they share the same target date. A 2035 fund from one mutual fund company may have a much greater percentage of assets invested in stocks—making it more aggressively positioned than a mutual fund with the same date from a different mutual fund company.
In other words, you need to consider the level of risk the fund takes to help meet its objectives. Each fund has a unique formula to determine the right mix of stocks and bonds for (1) each target date, (2) the number of years until the target date, and (3) the relative level of risk being assumed.
The fund’s investment mix typically becomes less risky as the target date nears, but you need to be sure you’re comfortable with volatility throughout its life. Selecting the right target date fund is made more difficult if your risk tolerance changes as retirement nears.
In other words, you need to fully understand the strategy behind the fund’s approach before making an investment into it.
- Difference in glide paths. While the asset mix of your target date fund is important, how the fund gradually shifts from stocks to bonds—also known as its “glide path”—is equally important. Knowing which kind of glide path your target date fund is using is essential as you plan for your retirement.
- A “to” glide path means that the fund becomes more conservative as the target date approaches (moving to a greater bond-to-stock ratio) and then remains static once it gets to the retirement date.
- A “through” glide path is often used by mutual funds designed for those who will likely stay invested long after the target date is reached. The glide path continues through the retirement date. The “through” path generally keeps the asset mix more aggressive (more stocks compared to bonds) than the funds that use a “to” path.
Target date funds are a good solution for some investors but aren’t always as “hands-off” as they may appear. And they may be too aggressive or conservative for your individual risk tolerance.
Target risk funds
Target risk funds build a mix of stocks and bonds that align to a particular risk level:
- An aggressive target risk fund may put 75% to 100% of its assets into stocks (with the remaining assets in bonds).
- A conservative target risk fund might have the opposite asset mix (nearly all bonds with limited stock holdings).
Generally, younger investors will put their money into more aggressive target risk funds and focus on growing their assets. Older investors tend to use more conservative allocations to protect their assets as retirement grows closer.
Here’s a closer look at what these funds offer.
- A straight-forward way to manage risk. Much like target date funds, target risk funds offer a single, balanced solution for you to diversify the investments and tailor them specifically to your desired risk level.
- Unlike a target date fund, if you invest in a target risk fund, you only have to select the right risk level and don’t need to worry about the additional complexities of glide paths or the significant variations between funds with the same target dates. With target risk funds, however, the investor is responsible for identifying when risk tolerances change and moving investments to a fund with the appropriate risk level.
- An aggressive target risk fund gives you an aggressive mix. A conservative target risk fund offers a more conservative investment.
- More investment flexibility. Target risk funds—unlike target date funds—are built on the assumption that your portfolio will probably have more than one investment account. This means target risk funds can offer you more flexibility based on your situation.
For example, if you’re an older investor with the majority of your assets sitting in bond funds in a 401(k), a small allocation to an aggressive target risk fund in an IRA might be the right choice for you. A target date fund doesn’t offer the same flexibility—the closer the target date, the more conservative the investment mix.
No matter what your planned retirement age is, you can get the right investment mix with a target risk fund based on your risk profile. You can also update it as your investing needs evolve. Keep in mind, you will be responsible for adjusting your investments as your risk tolerance changes.
