Target date funds & how to choose one
These funds help offer ease and convenience to investors with longer time horizons.
- A target date fund can be used for retirement or future expenses.
- Funds are typically more aggressive in the beginning.
- Funds reallocate throughout the years.
- As the target date gets closer, funds become more conservative.
What is a target date fund?
Target-Date Funds (TDFs) are a class of mutual funds and typically used as a way for investors to save for future expenses and retirement. These funds are typically named for the year they’re expected to be used, are usually set up in 5-year intervals and are structured for long-term growth. Funds with the same target date can have different holdings, so it’s helpful to explore each fund individually before selecting.
TDFs are typically more aggressive early on and become more conservative near the target date; this relieves investors from adjusting the mix of stocks, bonds and cash equivalents within the portfolio as the date nears. The adjustments make TDFs a simple option for investing.
Are target date funds good?
As with other mutual funds, TDFs offer investors convenient access to diversification. Each share of the fund grants an investor part ownership of every security in which the fund invests — and thus exposure to a broad swath of companies, industries and sectors. Holding a range of stocks (aka equities) and bonds in your portfolio helps to diversify the fund and reduce the likelihood that a decline in value of a specific company, industry or geographic region will negatively affect your performance.
Target date funds pros and cons
TDFs have grown more popular over the years. In 2005, year-end U.S. assets held in TDFs were $70 billion. According to Bankrate, the amount invested in TDFs has risen to $2.8 trillion as of 2022. Target date funds also have some pros and cons associated with them.
Target date fund pros
Target date funds can help simplify your choices when investing for retirement. When choosing a TDF, you can simply choose the year you plan to retire, and whether you are more comfortable with conservative, moderate or aggressive risks.
Another advantage unique to TDFs is their glide path, or the gradual shift in the fund's mix of stocks and bonds over time. The glide path is typically anchored around a target retirement date, with a shift to a more conservative allocation — namely less exposure to stocks and more exposure to bonds — as that target date approaches. Stocks tend to produce higher returns than bonds over the long term, but they are typically subject to higher short-term volatility. By automating this shift in allocation, TDFs help investors avoid a situation in which they are left holding more risk in their retirement savings than they should as they approach retirement age.
Target date fund cons
The best TDF for one person, may not also be the best one for you. While each fund claims to be a good choice for an investor targeting a specific retirement year, TDFs have different allocations and strategies to help get you to your end goal.
Since TDFs are investments, not annuities, the fund can fluctuate and perform either better or worse than expected.
Also, expenses related to the management of your TDF can be higher than traditional mutual funds. Do some research before choosing a target date fund to ensure that you are not paying more than you need to.
How do you choose a target date fund?
Since target date funds operate on the common principle of a glide path centered around the year in which you expect to start using the funds, the name of the fund typically includes that year. But the specifics of the glide path can vary from fund to fund, particularly around the mix of stocks and bonds they hold. To choose the right TDF for you, start by looking for ones with target dates close to the date you will use the funds, then choose one that matches your risk tolerance.
TDFs can differ in their mix of assets along any point of the glide path, and they can differ in terms of how quickly that mix shifts over time. A more aggressive investor may invest in a TDF that offers more exposure to equities early during the investment or may choose one that maintains a higher allocation to stocks at the target date. Funds also vary based on their level of exposure to different sectors of the market and even different types of securities. These factors can affect the level of risk or return you can expect, even if funds share the same target date.
What to know
- Glide path: The changing mix of stocks, bonds and cash equivalents becomes more conservative over time.
- Time horizon: Pick a target date that matches the year you will need the funds.
- Risk tolerance: Generally, your tolerance to risk lowers as you get closer to the target date.
What to consider
- Is the fund actively or passively managed?
- Is there a focus on domestic or international exposure?
- Have alternative assets been included to manage risk?
- Have you accounted for fund fees?
- Will the fund carry you to or through retirement?
Not all investors have the same tolerance for risk, so it's worth shopping around for one that best suits your comfort level. And if you want to dive into the investment world, but are still unsure of where to start, a financial advisor could be a good resource.