What Is A Target-Date Fund?
A target-date fund is a type of mutual fund or exchange-traded fund that rebalances its portfolio to achieve the best balance between risk and return for a specific period of time. A target date fund's asset allocation strategy is such that it gradually moves to a more conservative profile to minimize risk as the target date approaches. Target-date funds typically mature at five-year intervals. In this article, we will discuss how target-date funds work, their advantages and disadvantages, and why they are a popular investment option for investors.
How Does A Target-Date Fund Work?
Target-date funds have a predetermined time frame, and they are usually named after the year in which the investor plans to start using the assets. The target-date fund managers use this time frame to develop their investment strategy, which is generally based on traditional asset allocation models. These managers also use the target date to determine the level of risk that the fund is willing to undertake. Generally, target-date portfolio managers readjust the portfolio risk levels annually.
The asset allocation of a target-date fund initially has a high tolerance for risk and is therefore heavily weighted towards high-performing but risky assets. However, as it approaches its objective target date, the portfolio mix of assets and the degree of risk become more conservative. Higher-risk portfolio investments in target-date funds usually include domestic and global equities, while lower-risk portions of a target-date portfolio include fixed-income investments such as bonds and cash equivalents.
Some target-date funds, known as “through” funds, manage funds to a specified asset allocation past the target date, while others, known as “to funds,” cease any modifications to asset allocation once the target date is reached.
Benefits Of Target Date Funds
Target-date funds offer investors the ease of putting their investing activities on autopilot. They are popular with busy investors, as instead of having to choose several investments to create a portfolio that will help them reach their retirement goals, investors choose just one target-date fund that suits their financial goals and time requirements. After an investor picks a fund, it becomes a sort of set-it-and-forget-it investment that somewhat negates the need for other assets.
Disadvantages Of Target-Date Funds
The autopilot nature of target-date funds may not suit an investor's changing goals and needs over time. Moreover, there is no guarantee that the fund's earnings will keep up with inflation, and generate a specific amount of income or gains, or perform well. As is the case with other investments, target-date funds are also subject to risk and underperformance.
Furthermore, target-date funds can be expensive compared to mutual as they are technically a fund comprised of other funds, which means that investors have to pay the expenses of those underlying funds, as well as the fees of the target-date fund.
Why are Target-Date Funds Popular?
Target-date funds are an attractive investment option because they provide a very simple one-step approach that mitigates the need for other assets. They are usually used by investors who are saving towards retirement and are also used by people working towards a future big expense, such as a buying a house. These funds allow investors to set and forget their investments, freeing them from the constant monitoring of their investments.
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