Target date funds (TDFs) mix several different types of stocks, bonds and other investments to help you take more risks when you’re young, and gradually get more conservative in your investment strategy over time.
Simply put, target date funds help take the guesswork out of saving for retirement. They are typically the best investment strategies for most people planning for retirement, because they provide a diversified mix of equities and fixed income that rebalances over time.
How do target date funds work?
Investors can take more risk when they’re younger, as they can weather the typical ups and downs of the stock market over a long term horizon. But as investors get close to their retirement, the fund moves toward lower risk options accordingly. Target date funds can be actively managed or passively designed against indices or pre-set benchmarks.
To put this thinking in context, a 22-year-old teacher planning to retire at age 66 might invest in a target date 2060 fund. The target date in the name of the fund is the approximate date that an investor plans to start withdrawing money. Over time, as the teacher moves closer to the target date (2060), a portfolio manager will rebalance the fund so that it becomes more conservative, with fewer equities and more fixed income. The principal value is not guaranteed at any time, including at the target date. Because of this, it’s important to know how your target date fund is set up and that you monitor your investments, whether personal or through your employer, as this investment strategy is quite common through workplace retirement plans.
In a managed fund, a portfolio manager would manage investment options with a tool called a “glidepath” to adjust the underlying mix of investments that make up your target date fund. A glidepath is like an investment roadmap. It helps determine what the risk exposure in your fund should be over the course of your career. Learn more about how a glidepath evaluates different investment products in building out a target date fund.
What is a glidepath?
Why consider target date funds?
Target date funds make it easy for people looking to save for retirement to potentially maximize their future retirement income. If you have a 401(k) plan, you may already be invested in a target date fund, since many plans use them as their “default investment.” Depending on your retirement goals, there are several investment strategies you can consider when getting actively involved in selecting a target date fund.
What’s the best asset allocation for target date funds?
When considering the best target date funds for you, it’s important to note that different funds are designed with unique investment strategies in mind, and that can lead to different desired outcomes. Traditional target date funds typically follow set asset allocations or might be constructed to seek outperformance of certain benchmarks (like the S&P Target Date Indices, for example). These types of funds tend to be on the more conservative side and contribute to a balanced portfolio. On the other hand, goals-based target date funds aim to achieve specific outcomes and may be more likely to be associated with growth and income generation.
In practice, a goals-based investment strategy means the investor customizes the plan — such as managing risk, broadening the scope of investments or considering alternative investments — to help increase their chances of reaching their retirement goal. While the consistent goal of all retirement plans is to achieve a sustainable retirement income, investment needs can change, and a portfolio may need to change accordingly.
- Growth portfolios aim to increase the value of retirement savings by favoring stocks.
- Balanced portfolios typically focus on seeking moderate levels of return and risk by investing in a fairly even split between stocks and bonds.
- Income portfolios are designed to offer long-term sustainability through a generally conservative strategy of bonds, mortgage-backed securities, stocks and other investments that pay interest or dividends.
Are target date funds a good investment?
Target date funds are one tool to have in your arsenal to help minimize retirement risks as much as possible. Even with good habits in place, saving for retirement can be stressful and there are some risks that are beyond your control. What risk saving measures can you take with target date funds? Diversification and managing inflation.
What is diversification?
Diversification is an investment strategy that accounts for market turbulence, so if one kind of investment (let’s say stocks, for example) has a bad year, other types of investments (like bonds, in this case) might have an up year.
Longer life expectancies mean more time to invest, which, in turn, means more exposure to potential market downturns. Target date funds can help address the risk of market turbulence by providing diversification. Said differently, diversification is just another word for “Don’t put all your eggs in one basket.” Simple enough. But it’s important to pay attention to your asset allocations so you can respond when market uncertainties may strike.
How do target date funds manage inflation?
Target date funds can help manage inflation risk in two ways. First, by investing more heavily in equities earlier in your career, the idea is to grow your savings past the point of inflation. In addition, some TDFs invest in what are called “real assets” (such as Treasury Inflation-Protected Securities [TIPS] and real estate), which traditionally have helped hedge against inflation.
Let’s try out some real-life context. Let’s say you have $500,000 in savings set aside for retirement. How do you know if that’s enough? Part of the answer has to do with how much that money will be worth when you actually retire. Inflation risk refers to the concern that your money will be worth less in the future, and you might not have enough to meet your retirement goals. Learn how target date funds are designed to help keep inflation from chipping away at hard earned savings.