What is a ‘Target-Date Fund’
A target-date fund is a fund option that automatically resets the allocation of stocks, bonds and cash holdings according to a selected time frame that is aligned with an expected liquidation date for a particular investor. A target-date fund is structured to address some date in the future, such as retirement. Like anything, the returns are not guaranteed and are subject to the return of the market.
Above is an example of what we call the “glide-path.” As you near your target date, the fund will shift more of your investment from stocks (riskier assets) to bonds (less risky assets) with the intention to protect accumulated wealth in the latter years of your career before retirement.
For example, a younger worker hoping to retire in 2060 would choose a target-date 2060 fund, while an older worker hoping to retire in 2020 would choose a target-date 2020 fund. Because the younger investor has a longer investment horizon, the 2060 fund is weighted heavily toward stocks, with a relatively small percentage of bonds and cash equivalents. The older worker in the 2020 fund would hold relatively more bonds and cash equivalents with far fewer stocks, as the older worker’s fund should be exposed to lower volatility assets and protected from large drawdowns.
Target-date funds are very popular with retirement investors, and it is common to find them within 401k offerings. Instead of actively choosing a number of investments to create a portfolio, investors simply choose a single fund that employs a systematic method of asset allocation over a long time horizon. As opposed to actively managing the asset allocation decision yourself over the timeline of your career, the fund’s managers will re-balance holdings periodically, ensuring the target asset allocation scheme is in line with the investors time horizon and risk tolerance.
There are, however, a number of things to consider before using a target date fund. First, they are not the most tax efficient vehicles, which is why most target date funds are held inside of retirement accounts, as they are tax deffered plans. Additionally, investors should take the time to understand the asset allocation mix of the fund. Even though you may have every intention of retiring in 2050, certain investors may be more/less risk averse than their peers; so make sure you are aligning your risk tolerance – which has most to do with time horizon of investment – to the funds underlying holdings.
To our loyal podcast listeners, we discuss target-date funds in further detail on Episode 9 of The Investment Advisors Podcast, which is being released April 21st, 2017.
Disclaimer: This information is for educational purposes only and should not be construed as investment advice. Please refer to our full Disclaimer for more information