A Target Retirement Fund, also known as a target-date fund, is a group of investment securities that, bundled together, are expected to create returns over a specific time period. They are long-term investments. If you have a 401(k), you might have seen these things called “Target Retirement Fund 20XX” where the X’s are the year you plan to retire.
Most people use them as a way to grow their money for retirement.
But they are not magic. If you are 25 and invest in a Target Retirement Fund targeting the year you turn 30 years old, that doesn’t mean you’ll have enough money to retire at age 30. Maybe you are thinking, duh, what do you think I am, some kind of dummy? No, no we were not thinking that! We are nice and easy-going. We would never judge a person based on their knowledge of target-date funds! That’s why we wrote this blog post!
*Clears throat*
So, if you are thinking of investing your retirement money in a target retirement fund, here’s what you need to know.
What Are Target-Date Funds?
Target-date funds try to give you a certain return on your money in a certain time frame. They are mostly used for retirement, but you could use them to save for other things in the distant future, like saving for your kid’s education or buying a home.
Target-date funds are structured as mutual funds. Target-date funds are made of shares of other funds that contain portfolios of stocks or bonds. Fancy finance people refer to these as funds of funds.
Think of those wooden Russian dolls you used to play with as a kid in craft stores while your mom was shopping. (No? Just us?) Inside the target-date fund are several funds, which then also contain funds.
Target-date-funds: Fund inside fund.
The point is, target-date funds give you exposure to many different assets. Lots, actually. Sometimes it can be hard to look into everything you get exposure to through a target-date fund.
Why Invest in a Target-Date Fund?
The benefit of target-date funds is they automatically recalibrate every year to the appropriate risk allocation for your goals. As you age, your money will be invested in fewer stocks and more bonds without you lifting a finger.
They also make investing for retirement simpler. You simply pick the right target date for you, contribute regularly, and your investments will be redistributed every year to an appropriate risk allocation.
Plus, it means you technically can worry less about major market movements. Target-date funds are meant for long-term investing, earning a return despite stock market volatility. Plop your money in and enjoy the ride all the way to retirement. (Hopefully. No guarantees.)
What You Need to Know About Target-Date Retirement Funds
Target-date funds are:
- Managed by professional asset managers
- Vanguard, Schwab, Fidelity, T. Rowe Price: a sampling of the names you’ll see next to the target-date funds offered by your 401k plan or IRA
- Why this matters: often the investments inside the target date fund are other funds made by the same company.
- Which means by buying a target-date fund, you’re putting all your eggs in the same asset manager basket. If the firm makes some critical bad assumptions, you could pay for it
- Often the default investment if you don’t manage your 401k
- If you procrastinated on investing your 401k money, some companies will automatically enroll employees in a target-date retirement fund based on your age and assumed retirement date.
- So if you know you’re contributing to your work retirement fund but have no idea what’s happening to the money…hi. That’s what’s up.
- Automatically reallocated each year
- Target-date funds are kinda like a good cocktail: you got one part short-term debt, two parts domestic equities, and a splash of foreign stocks.
- In other words: they’re a mix. When investments earn returns, the percentage of the portfolio made up of domestic stocks might be higher than before. Which requires a little thing we call reallocation, aka keeping the percent in bonds and percent in bonds consistent with the risk profile. With target-date funds, the reallocation happens automatically.
- Not designed to work with other investments
- What we mean by this: Because Target Date Funds assume your risk tolerance, if you put a portion of your retirement savings into a Target Retirement Fund and then put the rest into a stock or bond ETF, you are potentially taking on more risk than appropriate for you, depending on your age and financial profile.
- Not a guarantee you’ll have enough money for retirement
- Just because you pick a target-date retirement fund for the year you plan to retire doesn’t mean you’ll hit your goal. It depends on how much money you invest and how well the markets do.
Pros and Cons of Target-Date Funds
Pros
Easy, automatic investing: Set it and forget it for your retirement savings
No need for other investments: Meant to be your only investment in a retirement account. This could be considered a con if you fancy picking some of your own stocks or other investments
Automatically reallocates your investments: The fund does the reallocation work for you.
Cons
Can be expensive: Because target-date funds are funds of funds (Russian doll version of investing) you have to pay expense ratios of both the target date fund and all the mutual funds inside
Limits exposure to one security firm’s funds: For example, a Vanguard target-date fund solely invests in other Vanguard mutual funds or portfolios.
Lack of personalization: Target-date funds are generic and not personalized to fit your individual needs
No guarantee the return will be high enough for retirement. But this is true no matter how you invest. There are no guarantees in life!! Even dogs have to work for their bones!
How to Choose a Target-Date Fund
Target-date funds make it very easy for you to choose the right fund. Simply calculate what year you’re likely to retire (ie. if you’re 25 and you plan to retire when you’re 65, that’s 40 years from now. 2021 + 40 = 2061, so you would choose the 2061 Target-Date Fund.)
The longer from retirement, the more stocks the target-date fund will hold. Fidelity’s target-date fund for 2025, for example, contains a lower percentage of equities than its 2065 target-date fund.
That’s really all there is to it.
RECAP
Target-date funds are mutual funds that contain different allocations of stocks and bonds meant to invest your money for retirement.
The funds are named by year. You buy the one for the year you expect to retire, assuming you aren’t planning to retire early.
Your earnings are automatically reinvested and asset allocations are automatically recalibrated each year to be suitable for the [generic] risk profile of your aging bones.
