Target date funds
Target date funds offer a straightforward way to diversify investments. 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 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 2040 fund from one mutual fund company may be set up with a 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 that has a heavier balance of bonds.
This means you need to consider the level of risk the fund takes to help meet its objectives. Each fund will have 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 uses is essential as you plan for retirement.
A “to” glide path means 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 investors who will likely stay invested long after the target date is reached. This 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 may seem a good solution, but investors should be aware, the funds aren’t always as hands-off as they may appear. And they may be too aggressive or conservative for your individual risk tolerance.