Like any investment, there are pros and cons to using target date funds for retirement savings. The concept is easy to grasp—just pick the year you want to retire and select that fund that’s closest to that year. Say you’re 50 and you want to retire in 2034. You’d pick the 2035 fund. The fund is actively managed and rebalanced to adjust risks, as you get closer to retirement, explains Kiplinger in the article “Is a Target Date Fund Right for You?”
Target date funds are a good option for investors who aren’t intimately involved with their investments and who wouldn’t rebalance their investments on their own. These funds are also good for DIY investors because they’re a more comprehensive strategy than selecting funds based on past performance—which is the method often used by do-it-yourselfers. However, past performance doesn’t always indicate future growth.
On the downside, target date funds aren’t individualized for an individual’s specific situation. Instead, they treat every person who will retire in a certain year the same. However, people should have an individualized income plan for retirement, and target date funds aren’t able to do that. Target date funds should be a component of a complete retirement plan. Here a few things to consider with target date funds.
Diversification. Retirement savers should divide their money between the different types of asset classes. This includes liquid assets that you can readily access, growth assets and safe assets—and it’s also important to diversify your assets within each of these categories.
Fees. Examine a target date fund’s prospectus and cost. Target date fund fees have been dropping in recent years, with the average fee of roughly $66 on a $10,000 investment. See if the fund is actively or passively managed. An actively managed fund has a money manager purchasing and selling equities in the fund. A passive fund will have a greater number of index funds and lower fees.
Risk. Some target date funds assume greater risk than others. Research this to discover the level of risk that you’re assuming.
Asset Allocation. Look at the companies and industries in which the target date fund is invested. Find out in which companies the fund is invested and search for a target date fund that aligns with your objectives.
Target date funds could be a great way to save for retirement, if you’re too busy to manage your own investments and understand the importance of continuing to put money away for retirement. Saving early and often is the best way to build a strong retirement nest egg. Target date funds can help.
Reference: Kiplinger (July 23, 2019) “Is a Target Date Fund Right for You?”