Target date funds are becoming increasingly popular as an element of retirement and investment portfolios. By the end of 2017, there were more than $1.11 trillion in assets in target date funds, up from $880 billion in 2016, and a mere $158 billion in 2008. In other words, there are nearly 10 times more assets in target date funds today than there were just a decade ago.
There are many factors responsible for this, including decreased fees for target date funds and a bigger push from investment advisors to get their clients involved. But are these funds really the right choice for investors?
The Basics
A target date fund is a mutual fund or collective trust fund whose asset allocation changes dynamically to the age of the person investing in it. Younger investors, who are many decades away from retirement, start with a strong growth objective, and higher-risk assets intended to facilitate growth. As investors get older, the asset allocation in target date funds gradually becomes more conservative, including more low-risk, low-yield investments, until the “target date”—retirement—approaches.
Points of Value
There are a few key advantages to this method of investment:
- Diversification. Portfolio diversification is an important consideration no matter what your goals are, and target date funds are diverse by nature. You won’t have to worry about manually allocating your principal into different areas; instead, you’ll be exposed to domestic stocks, foreign stocks, bonds, and other assets in a mix determined by an investment professional or team.
- Low maintenance. Target date funds are perfect for investors who either don’t have much experience or for those who don’t want to actively manage their money. Little to no action is required on behalf of the investor; instead, your portfolio is readjusted automatically over the years.
- Low fees. For the most part, target date funds have low expense ratios, though this isn’t always true. The average weighted expense ratio in 2017, for example, was just 0.66. Compared to other mutual funds, this is quite affordable, though many ETFs and individual assets won’t charge any ongoing expenses at all.
- Flexibility. There’s more than one type of target date fund available, giving you access to options that are more conservative or more aggressive, as well as distributions that focus on a particular sector or type of asset. You can also set your own target date, so if you plan on retiring early, you can allocate your resources accordingly.
Key Weaknesses
However, target date funds aren’t the all-powerful, flawless investment choices they’re often claimed to be. There are several weaknesses to keep in mind:
- Generalization. First, target date funds are designed to appeal to the greatest number of people possible. An energetic young professional with no kids, a low salary, and hopes of retiring early could easily be roped into the same asset allocation as someone older with a spouse and children, a six-figure salary, and no plans for retirement. These two individuals have very different goals, different lifestyles, and different levels of resources, so they should have very different portfolios. However, target date funds don’t offer much wiggle room.
- Conservative bias. Most target date funds end up being more conservative than they need to be. There are several reasons for this, including the need to keep investors happy with minimal volatility in the event of an economic downturn. However, if you’re in your 30s and aren’t planning on retiring for another 30 years, you may find yourself far more invested in bonds and other low-risk securities than you need to be. By the time you start approaching your target retirement age, you’ll be so heavily invested in conservative assets, your growth rate will shrink to almost unreasonable levels.
- Passive nature. For many investors, the passive nature of target date funds is a massive benefit—it means they don’t have to think about how their portfolio is performing. But in most cases, this is actually a disadvantage. While the “buy and hold” strategy is good, and you shouldn’t be deterred from your strategy by unexpected volatility, there are still cases when you’ll want to sell a stock or rebalance your portfolio on the fly, like if you anticipate a recession in the coming years.
For many retirement-conscious investors, target date funds are an approachable, convenient, and reliable choice. But before you pool your entire nest egg into a target date fund, it’s important to research your other options, and be aware of their inherent limitations. Leaving one of your investment accounts, like a 401(k), to a target date fund or allocating a portion of your portfolio to a target date fund may be your best option. Use your remaining funds to build a portfolio that more closely aligns with your long-term financial goals.
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